Clearing Agency Standards for Operation and Governance

Federal RegisterMar 16, 2011

Ask Donna

What actually matters in this document.

Text

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-64017; File No. S7-08-11]

RIN 3235-AL13

Clearing Agency Standards for Operation and Governance

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

In accordance with Section 763 of Title VII (“Title VII”) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), Section 805 of Title VIII (“Title VIII”) of the Dodd-Frank Act, and Section 17A of the Securities Exchange Act of 1934 (“Exchange Act”), the Securities and Exchange Commission (“SEC” or “Commission”) is proposing rules regarding registration of clearing agencies and standards for the operation and governance of clearing agencies. The proposed rules are designed to enhance the regulatory framework for the supervision of clearing agencies.

DATES:

Comments should be submitted on or before April 29, 2011.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form (

http://www.sec.gov/rules/proposed.shtml

); or

• Send an e-mail to

rule-comments@sec.gov

. Please include File Number S7-8-11 on the subject line; or

• Use the Federal eRulemaking Portal (

http://www.regulations.gov

). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F St., NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-8-11. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (

http://www.sec.gov/rules/proposed.shtml

). Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F St., NE., Washington, DC 20549 on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

Jeffrey Mooney, Assistant Director; Peter Curley, Attorney Fellow; Andrew Blake, Special Counsel; Michael Milone, Special Counsel; Alison Duncan, Attorney-Adviser; Marta Chaffee, Branch Chief; and Andrew Bernstein, Attorney-Adviser, Office of Clearance and Settlement, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-7010 at (202) 551-5710.

SUPPLEMENTARY INFORMATION:

The Commission is proposing seven new rules and an amendment to an existing rule related to clearing agencies, including security-based swap clearing agencies. The proposed rules are designed to enhance the regulatory framework for the supervision of clearing agencies. Specifically, the Commission is proposing to: (1) Identify certain minimum standards for all clearing agencies; (2) require dissemination of pricing and valuation information by security-based swap clearing agencies that perform central counterparty services; (3) require all clearing agencies to have adequate safeguards and procedures to protect the confidentiality of trading information of clearing agency participants; (4) exempt certain security-based swap dealers and security-based swap execution facilities from the definition of a clearing agency; (5) amend rules concerning registration of clearing agencies to account for security-based swap clearing agencies and to make other technical changes; (6) require all clearing agencies to have procedures that identify and address conflicts of interest; (7) require standards for all members of clearing agency boards of directors or committees; and (8) require all clearing agencies to designate a chief compliance officer.

I. Introduction

On July 21, 2010, President Barack Obama signed the Dodd-Frank Act into law.

The Dodd-Frank Act was enacted to, among other things, promote the financial stability of the United States by improving accountability and transparency in the financial system.

Title VII of the Dodd-Frank Act provides the Commission and the Commodity Futures Trading Commission (“CFTC”) with the authority to regulate over-the-counter (“OTC”) derivatives in light of the recent financial crisis, which demonstrated the need for enhanced regulation of the OTC derivatives market. The Dodd-Frank Act is intended to bolster the existing regulatory structure and to provide the Commission and the CFTC with effective regulatory tools to oversee the OTC derivatives market, which has grown exponentially in recent years and is capable of affecting significant sectors of the U.S. economy.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).

Id.

at Preamble.

See

156 Cong. Rec. 5878 (daily ed. July 15, 2010) (statement of Sen. Dodd).

The Dodd-Frank Act provides that the CFTC will regulate “swaps,” the Commission will regulate “security-based swaps,” and the CFTC and the Commission will jointly regulate “mixed swaps.”

The Dodd-Frank Act amends the Exchange Act to require, among other things, the following: (1) Transactions in security-based swaps must be cleared through a clearing agency if they are of a type that the Commission determines must be cleared, unless an exemption from mandatory clearing applies; (2) transactions in security-based swaps must be reported to a registered security-based swap data repository or the Commission; and (3) if a security-

based swap is subject to a clearing requirement, it must be traded on a registered trading platform,

i.e.,

a security-based swap execution facility or exchange, unless no facility makes such security-based swap available for trading.

The Commission and the CFTC, in consultation with the Board of Governors of the Federal Reserve System (“Federal Reserve”), shall jointly further define the terms “swap,” “security-based swap,” “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” “eligible contract participant,” and “security-based swap agreement.” Public Law 111-203 § 712(d). Except for the term “eligible contract participant”, these terms are defined in Sections 721 and 761 of the Dodd-Frank Act. Public Law 111-203 §§ 721, 761. The term “eligible contract participant,” is defined in Section 1a(18) of the Commodity Exchange Act (“CEA”), 7 U.S.C. 1a(18), as re-designated and amended by Section 721 of the Dodd-Frank Act. Public Law 111-203 § 721. Further, Sections 721(c) and 761(b) of the Dodd-Frank Act respectively require the CFTC to adopt rules to further define the terms “swap,” “swap dealer,” “major swap participant,” and “eligible contract participant,” and permit the Commission to adopt rules to further define the terms “security-based swap,” “security-based swap dealer,” “major security-based swap participant,” and “eligible contract participant,” with regard to security-based swaps, for the purpose of including transactions and entities that have been structured to evade Title VII of the Dodd-Frank Act. Public Law 111-203 §§ 721(c), 761(b). Finally, Section 712(a) of the Dodd-Frank Act provides that the Commission and CFTC, after consultation with the Federal Reserve, shall jointly prescribe regulations regarding “mixed swaps,” as may be necessary to carry out the purposes of Title VII. Public Law 111-203 § 712(a). Consistent with the Dodd-Frank statutory structure described above, the Commission and CFTC have proposed rules to define these terms.

See

Exchange Act No. 63452 (December 7, 2010), 75 FR 80174 (December 21, 2010).

Section 761 of the Dodd-Frank Act adds Section 3(a)(77) to the Exchange Act, which defines the term “security-based swap execution facility” to mean “a trading system or platform in which multiple participants have the ability to execute or trade security-based swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce, including any trading facility that (A) facilitates the execution of security-based swaps between persons; and (B) is not a national securities exchange.”

See

Public Law 111-203 § 761. The decision of a security-based swap execution facility or exchange to list a security-based swap contract for trading may not be sufficient to establish that the contract is “made available for trading” by that security-based swap execution facility or exchange and therefore cannot be traded in the over-the-counter market.

See

Exchange Act Release No. 63825 (February 2, 2011), 76 FR 10948 (February 28, 2011). The Dodd-Frank Act amends the CEA to provide for a similar regulatory framework with respect to transactions in swaps regulated by the CFTC.

Beginning in December of 2008, the Commission acted to facilitate the clearing of OTC security-based swaps by permitting certain clearing agencies to clear credit default swaps (“CDS”) on a temporary conditional basis.

Consequently, a significant volume of security-based swaps in the form of CDS transactions are centrally cleared today, and the Commission oversees those activities pursuant to the CDS Clearing Exemption Orders.

The Commission authorized five entities to clear credit default swaps.

See

Exchange Act Release Nos. 60372 (July 23, 2009), 74 FR 37748 (July 29, 2009), 61973 (April 23, 2010), 75 FR 22656 (April 29, 2010) and 63389 (November 29, 2010), 75 FR 75520 (December 3, 2010) (CDS clearing by ICE Clear Europe Limited); 60373 (July 23, 2009), 74 FR 37740 (July 29, 2009), 61975 (April 23, 2010), 75 FR 22641 (April 29, 2010) and 63390 (November 29, 2010), 75 FR 75518 (December 3, 2010), (CDS clearing by Eurex Clearing AG); 59578 (March 13, 2009), 74 FR 11781 (March 19, 2009), 61164 (December 14, 2009), 74 FR 67258 (December 18, 2009), 61803 (March 30, 2010), 75 FR 17181 (April 5, 2010) and 63388 (November 29, 2010), 75 FR 75522 (December 3, 2010) (CDS clearing by Chicago Mercantile Exchange Inc.); 59527 (March 6, 2009), 74 FR 10791 (March 12, 2009), 61119 (December 4, 2009), 74 FR 65554 (December 10, 2009), 61662 (March 5, 2010), 75 FR 11589 (March 11, 2010) and 63387 (November 29, 2010) 75 FR 75502 (December 3, 2010) (CDS clearing by ICE Trust US LLC); 59164 (December 24, 2008), 74 FR 139 (January 2, 2009) (temporary CDS clearing by LIFFE A&M and LCH.Clearnet Ltd.) (collectively, “CDS Clearing Exemption Orders”). LIFFE A&M and LCH.Clearnet Ltd. allowed their order to lapse without seeking renewal.

Most cleared CDS transactions have cleared at ICE Trust US LLC (“ICE Trust”) or ICE Clear Europe Limited (“ICE Clear Europe”). However, Eurex Clearing AG (“Eurex”) and the Chicago Mercantile Exchange Inc. (“CME”) are also authorized to operate pursuant to the CDS Clearing Exemption Orders. As of October 8, 2010, ICE Trust had cleared approximately $7.1 trillion notional amount of CDS contracts based on indices of securities and approximately $490 billion notional amount of CDS contracts based on individual reference entities or securities. As of October 8, 2010, ICE Clear Europe had cleared approximately €3.09 trillion notional amount of CDS contracts based on indices of securities and approximately €560 billion notional amount of CDS contracts based on individual reference entities or securities.

See

https://www.theice.com/marketdata/reports/ReportCenter.shtml

. The Commission has obtained data from The Depository Trust and Clearing Corporation on new and assigned CDS trades in United States Dollars during the month of November 2010 for ICE Trust. Cleared CDS trades represented a small fraction of total trades. Specifically, cleared trades were 5.24% by notional amount of all new or assigned single name trades, and 20.69% by notional amount of all new or assigned index trades.

II. Prescribed Rulemaking for Clearing Agencies

A. Title VII of Dodd-Frank Act

Title VII of the Dodd-Frank Act added new provisions to the Exchange Act that require clearing agencies that clear security-based swaps (“security-based swap clearing agencies”) to register with the Commission

and require the Commission to adopt rules with respect to security-based swap clearing agencies.

Public Law 111-203 § 763(b) (adding subparagraph (g) to Section 17A of the Exchange Act. Pursuant to Section 774 of the Dodd-Frank Act, the requirement in Section 17A(g) of the Exchange Act for securities-based swap clearing agencies to be registered with the Commission takes effect on July 16, 2011).

Public Law 111-203 § 763(b) (adding subparagraphs (i) and (j) to Section 17A of the Exchange Act).

Specifically, new Section 17A(j) of the Exchange Act requires the Commission to adopt rules governing security-based swap clearing agencies.

New Section 17A(i) of the Exchange Act also gives the Commission authority to promulgate rules that establish standards for security-based swap clearing agencies.

Compliance with any such rules is a prerequisite to the registration of a clearing agency with the Commission and is also a condition to the maintenance of that security-based swap clearing agency's continued registration.

Public Law 111-203 § 763(b) (adding subparagraph (j) to Section 17A of the Exchange Act).

See also

Public Law 111-203 § 774 of the Dodd-Frank Act (requiring that the provisions of Title VII take effect on the later of 360 days after the date of the enactment or, to the extent a provision of Title VII requires a rulemaking, not less than 60 days after publication of the final rule or regulation implementing such provision).

Public Law 111-203 § 763(b) (adding subparagraph (i) to Section 17A of the Exchange Act).

Under the Exchange Act, a clearing agency can be registered with the Commission only if the Commission makes a determination that the clearing agency satisfies the requirements set forth in paragraphs (A) through (I) of Section 17A(b)(3) of the Exchange Act.

B. Payment, Clearing, and Settlement Supervision Act of 2010

Title VIII of the Dodd-Frank Act, entitled the Payment, Clearing, and Settlement Supervision Act of 2010 (“Clearing Supervision Act”), establishes an enhanced supervisory and risk control system for systemically important clearing agencies and other financial market utilities (“FMUs”).

It provides that the Commission may prescribe regulations containing risk management standards, taking into consideration relevant international standards and existing prudential requirements, for any designated clearing entities it regulates.

The Council has not to date made any designations with respect to whether any FMU is, or is likely to become, systemically important;

however, the

Commission believes it is beneficial to consider the requirements of the Clearing Supervision Act in its proposed rules for clearing agencies because the Clearing Supervision Act may apply to one or more clearing agencies in the future and the Commission preliminarily believes that its goals are consistent with the goals of Section 17A of the Exchange Act. Specifically, Congress recognized in the Clearing Supervision Act that the operation of multilateral payment, clearing or settlement activities may reduce risks for clearing participants and the broader financial system, while at the same time creating new risks that require multilateral payment, clearing or settlement activities to be well-designed and operated in a safe and sound manner.

The Clearing Supervision Act is designed, in part, to provide a regulatory framework to help deal with such risk management issues, which is generally consistent with the Exchange Act requirement that clearing agencies be organized in a manner so as to facilitate prompt and accurate clearance and settlement, safeguard securities and funds and protect investors.

See supra

note 1. Under Section 803 of the Clearing Supervision Act, clearing agencies may be FMUs. Therefore, the Commission may be the Supervisory Agency of a clearing agency that is designated as systemically important (“designated clearing entities”) by the Financial Stability Oversight Council (“Council”).

See

12 U.S.C. 5463. The definition of “FMU,” which is contained in Section 803(6) of the Clearing Supervision Act, contains a number of exclusions including, but not limited to, designated contract markets, registered futures associations, swap data repositories, swap execution facilities, national securities exchanges, national securities associations, alternative trading systems, security-based swap data repositories, security-based swap execution facilities, brokers, dealers, transfer agents, investment companies and futures commission merchants. 12 U.S.C. 5462(6)(B). The designation of systemic importance hinges on a determination by the Council that the failure of, or a disruption to, the functioning of the FMU could create, or increase, the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the financial system of the United States.

See

12 U.S.C. 5463(a)(2)(A)-(E). The designation of an FMU is significant, in part, because it will subject such designated entity to heightened oversight consistent with the terms of the Clearing Supervision Act. For example, the Clearing Supervision Act requires the Supervisory Agency to examine at least once annually any FMU that the Council has designated as systemically important. The Commission intends to conduct such annual statutory cycle examinations on the Commission's fiscal year basis. The Commission staff anticipates conducting the first annual statutory cycle examination of any designated FMU for which it is the Supervisory Agency in the annual cycle following such designation.

See

Section 805(a)(2) of the Clearing Supervision Act. Those regulations may govern “(A) the operations related to payment, clearing, and settlement activities of such designated clearing entities; and (B) the conduct of designated activities by such financial institutions.” 12 U.S.C. 5464(a)(2).

See

12 U.S.C 5321 (among other things establishing the Council and designating its voting and nonvoting members. In accordance with Section 804 of the Clearing Supervision Act, the Council has the authority, on a non-delegable basis and by a vote of not fewer than two-thirds of the members then serving, including the affirmative vote of its chairperson, to designate those FMUs that the Council determines are, or are likely to become, systemically important. The Council may,

using the same procedures as discussed above, rescind such designation if it determines that the FMU no longer meets the standards for systemic importance. Before making either determination, the Council is required to consult with the Federal Reserve and the relevant Supervisory Agency as determined in accordance with Section 803(8) of the Clearing Supervision Act).

See also

Section 804 setting forth the procedures for giving entities 30 days advance notice and the opportunity for a hearing prior to being designated as systemically important. 12 U.S.C. 5463.

12 U.S.C. 5461(a)(2).

See

15 U.S.C. 78q-1(b)(3)(A).

C. Section 17A of Exchange Act

As noted above, in addition to the new authority provided to the Commission under Titles VII and VIII of the Dodd-Frank Act, the Commission has existing authority over clearing agencies under the Exchange Act. For example, entities are required to register with the Commission pursuant to Section 17A of the Exchange Act

and Rule 17Ab2-1,

prior to performing the functions of a clearing agency. Under this registration system, the Commission is not permitted to grant registration unless it determines that the rules and operations of the clearing agency meet the standards set forth in Section 17A.

If a clearing agency is granted registration, the Commission oversees the clearing agency to facilitate compliance with the Exchange Act through the rule filing process for self-regulatory organizations (“SROs”) and through on-site examinations by Commission staff. Section 17A also gives the Commission authority to adopt rules for clearing agencies as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act and prohibits a registered clearing agency from engaging in any activity in contravention of these rules and regulations.

See

15 U.S.C. 78q-1(b).

See also

Public Law 111-203 § 763(b) (adding subparagraph (g) to Section 17 of the Exchange Act).

See

17 CFR 240.17b2-1.

Specifically, Sections 17A(b)(3)(A)-(I) identify determinations that the Commission must make about the rules and structure of a clearing agency prior to granting registration.

See

15 U.S.C. 78q-1(b)(3)(A)-(I). The staff of the Commission provided guidance on meeting the requirements of Section 17A in its Announcement of Standards for the Registration of Clearing Agencies.

See

Exchange Act Release No. 16900 (June 17, 1980), 45 FR 41920 (June 23, 1980).

See

15 U.S.C. 78q-1(d).

III. Proposed Rules Governing Clearing Agencies

The Commission is proposing several new rules that would set standards for the operation and governance of clearing agencies. As noted above, the Dodd-Frank Act specifically gives the Commission authority to regulate security-based swaps

and to adopt regulations addressing risk management standards for designated clearing entities that the Commission regulates. In addition to considering this specific directive in formulating the proposed rules, the Commission preliminarily believes that applying certain rules to all clearing agencies would promote financial stability, one of the goals of the Dodd-Frank Act, by facilitating prompt and accurate clearance and settlement of all securities transactions consistent with Section 17A of the Exchange Act while promoting the Dodd-Frank Act's stated aims of accountability and transparency.

See supra

note 4.

The types of clearing agencies that are subject to the proposed rules can be divided into four different categories: (i) Clearing agencies that offer central counterparty (“CCP”) services for transactions in securities that are not security-based swaps, (ii) clearing agencies that offer CCP services for transactions in securities that are security-based swaps; (iii) clearing agencies that provide non-CCP services for transactions in securities that are not security-based swaps; and (iv) clearing agencies that provide non-CCP services for transactions in securities that are security-based swaps. The table below illustrates how the proposed rules would apply to different types of clearing agencies. In general, as illustrated in column “A” in the table, clearing agencies offering CCP services (regardless of whether they offer those services for transactions in securities that are or are not security-based swaps) would be subject to most of the proposed rules.

Clearing agencies that offer only non-CCP services would only be subject to certain of the proposed rules, depending on whether they offer those services for transactions in securities that are not security-based swaps (as illustrated in column “B” in the table)

or that are security-based swaps (as illustrated in column “C” in the table).

As noted in the table, proposed Rule 17Aj-1 would only apply to CCPs for security-based swap transactions.

Within this category, as illustrated in column “B”, the proposed rules distinguish between clearing agencies that provide central securities depository services, and those that do not.

Application of Proposed Rules to Clearing Agencies

CCP Clearing Services for Securities that are or are not Security-Based Swaps (“SBS”)

Non-CCP Clearing Services in Securities that are not SBS

Non-CCP Clearing Services for Securities that are SBS

17Ad-22(b)(1): Measurement and management of credit exposures

○

17Ad-22(b)(2): Margin requirements

○

17Ad-22(b)(3): Financial resources

○

17Ad-22(b)(4): Model validation

○

17Ad-22(b)(5): Non-dealer access

○

17Ad-22(b)(6): Portfolio size and transaction volume thresholds restrictions

○

17Ad-22(b)(7): Net capital restrictions

○

17Ad-22(c)(1): Records of financial resources

○

17Ad-22(c)(2): Audited financial statements

○

17Ad-22(d)(1): Transparent and enforceable rules

○

17Ad-22(d)(2): Participation requirements

○

17Ad-22(d)(3): Custody of assets and investment risk

○

17Ad-22(d)(4): Identification and mitigation of operational risk

○

17Ad-22(d)(5): Money settlement risks

○

17Ad-22(d)(6): Cost-effectiveness

○

17Ad-22(d)(7): Links

○

17Ad-22(d)(8): Governance

○

17Ad-22(d)(9): Information on services

○

17Ad-22(d)(10): Immobilization and dematerialization of stock certificates

Would Only Apply to Clearing Agencies that Provide Central Securities Depository (“CSD”) Services

17Ad-22(d)(11): Default procedures

○

17Ad-22(d)(12): Timing of settlement finality

○

17Ad-22(d)(13): Delivery versus payment

○

17Ad-22(d)(14): Controls to address participants' failure to settle

Would Only Apply to Clearing Agencies that Provide CSD Services

17Ad-22(d)(15): Physical delivery risks

○

17Aj-1: Dissemination of pricing and valuation information

Would Only Apply to Clearing Agencies that Provide CCP Services for SBS

17Ad-23: Policies and procedures to protect confidentiality of trading information of participants

○

Amendments to Rule 17Ab2-1: Registration of clearing agencies

○

17Ad-25: Procedures to identify and address conflicts of interests

○

17Ad-26: Standards for board or board committee directors

○

3Cj-1: Designation of chief compliance officer

○

A. Proposed Rule 17Ad-22 Standards for All Clearing Agencies

The Commission is proposing Rule 17Ad-22 to augment the statutory requirements under the Exchange Act by establishing minimum requirements regarding how clearing agencies must maintain effective risk management procedures and controls as well as meet the statutory requirements under the Exchange Act on an ongoing basis. For a clearing agency to be registered under Section 17A, it must have the ability to facilitate the prompt and accurate clearance and settlement of transactions, safeguard investor funds and securities, remove impediments to and perfect the mechanism of a national clearance and settlement system, and generally protect investors.

Also, the clearing agency's rules must provide adequate access to qualified participants, fair representation of shareholders and participants, equitable pricing, fair discipline of participants, and must not impose any undue burden on competition.

Section 17A of the Exchange Act explicitly provides the Commission with discretion to update the rules for clearing agencies consistent with the Exchange Act.

Further, Section 805(a) of the Dodd-Frank Act directs the Commission to take into consideration relevant international standards and existing prudential requirements for clearing agencies that are designated as FMUs.

The current international standards most relevant to risk management of clearing agencies are the standards developed by the Technical Committee of the International Organization of Securities Commissions (“IOSCO”) and the Committee on Payment and Settlement Systems (“CPSS”) of the Bank for International Settlements that are contained in the following reports:

Recommendations for Securities Settlement Systems

(2001) (“RSSS”), and

Recommendations for Central Counterparties

(2004) (“RCCP”) (collectively “CPSS-IOSCO Recommendations”).

See

15 U.S.C. 78q-1.

See id.

12 U.S.C. 5464(a)(1).

The complete RSSS and RCCP Reports are available on the Web site of the Bank for International Settlements at

http://www.bis.org/publ/cpss46.htm

and

http://www.bis.org/publ/cpss64.htm

respectively.

The RSSS and RCCP Reports were drafted by IOSCO and CPSS (“Task Force”). The Task Force consisted of securities regulators and central bankers from 19 countries (

i.e.,

Australia, Belgium, Brazil, China, Czech Republic, France, Germany, Hong Kong, India, Italy, Japan, Malaysia, Mexico, The Netherlands, Saudi Arabia, Singapore, Spain, England, and the United States) and the European Union. The U.S. representatives on the Task Force included staff from the Commission, the Federal Reserve, and the CFTC. The Federal Reserve has incorporated the RSSS and RCCP, as well as the Core Principles for Systemically Important Payment Systems, in its Federal Reserve Policy on Payment System Risk. The Federal Reserve applies these standards in its supervisory process and expects systemically important systems, as determined by the Federal Reserve and subject to its authority, will complete a self-assessment against the standards set forth in the policy.

See

Policy on Payment System Risk, 72 FR 2518 (January 12, 2007).

The Commission preliminarily believes that certain aspects of the CPSS-IOSCO Recommendations should be made to clearly apply to clearing agencies and that such application would further the objectives and principles for clearing agencies under the Exchange Act and the Dodd-Frank Act, including those that are related to sound risk management practices and to fair and open access. These international standards were formulated by securities regulators and central banks to promote sound risk-management practices and encourage the safe design and operation of entities that provide clearance and settlement services. The Commission is proposing Rule 17Ad-22 (which is consistent with the CPSS-IOSCO Recommendations but reflects modifications designed to tailor the proposed rule to the Exchange Act and the U.S. clearance and settlement system) because the Commission preliminarily believes that the rule would help to facilitate prompt and accurate clearance and settlement, safeguard securities and funds and protect investors.

See

15 U.S.C. 78q-1(d).

The Commission preliminarily believes that the adoption of proposed Rule 17Ad-22, which is based on the CPSS-IOSCO Recommendations, and the application of this rule to all clearing agencies would have several important benefits, including providing a robust framework for assessing and addressing the risks within clearing agencies. The Commission requests comment on proposed Rule 17Ad-22 and the consideration of the CPSS-IOSCO Recommendations in connection with the proposed rule. The Commission also requests comment on whether the proposed rules are properly tailored to assess and address the risks at clearing agencies and whether they are sufficiently clear to enable clearing agencies to reasonably determine whether they are in compliance with the rules or whether the Commission should provide additional guidance.

Several clearing agencies have published their evaluations of their compliance with the CPSS-IOSCO Recommendations on their Web sites.

See

http://www.dtcc.com/legal/compliance/assessments.php.

In addition, several clearing agencies, as part of requests for the CDS Clearing Exemption Orders, have represented to the Commission that they met the standards set forth in the RCCP.

See supra

note 6.

The Commission notes that IOSCO and the CPSS are currently in the process of revising their existing sets of international standards.

This review is intended to strengthen and clarify the CPSS-IOSCO Recommendations, as well as the CPSS's existing standards for payment systems entitled:

Core Principles for Systemically Important Payment Systems.

The Commission may, as international standards evolve, consider additional modifications to its rules as the Commission determines is appropriate based on its own experience and the requirements under the Exchange Act.

In December 2009, IOSCO and CPSS began a comprehensive review of existing standards for FMUs, which includes the RSSS and RCCP. This review intends to strengthen and clarify the standards based on experience with the standards since their publication and specifically from lessons learned during the recent financial crisis.

Proposed Rule 17Ad-22 contains certain additional requirements that are not addressed or contemplated by international standards. For clearing agencies that perform CCP services, these additional requirements are found in the following proposed rules: (1) Rule 17Ad-22(b)(3), which would require heightened financial resources for clearing agencies that provide CCP services for securities that are security-based swaps; (2) Rule 17Ad-22(b)(5), which would prohibit membership restrictions based on dealer status; (3) Rule 17Ad-22(b)(6), which would prohibit membership restrictions based on minimum volume and transaction thresholds; (4) Rule 17Ad-22(b)(7), which would prohibit restrictions on clearing agency membership based on minimum net capital requirements of $50 million or more; and (5) Rule 17Ad-22(c)(1), which would require calculation and maintenance of records of the clearing agency's financial resources.

Proposed Rule 17Ad-22(c)(2) would apply to all clearing agencies and require them to post annual audited financial reports on their Web sites.

In addition, the Commission is proposing additional rules for all clearing agencies (whether or not they offer CCP services) that are not addressed or contemplated by the international standards. These proposed rules would: (1) Require dissemination of pricing and valuation information by security-based swap clearing agencies that perform CCP services (Proposed Rule 17Aj-1); (2) require all clearing agencies to have adequate safeguards and procedures to protect the confidentiality of trading information of

clearing agency participants (Proposed Rule 17Ad-23); (3) exempt certain security-based swap dealers and security-based swap execution facilities from the definition of a clearing agency (Proposed Rule 17Ad-24); (4) amend rules concerning registration of clearing agencies to account for security-based swap clearing agencies and to make other technical changes (Rule 17Ab2-1); (5) require all clearing agencies to have procedures that identify and address conflicts of interest (Proposed Rule 17A-25); (6) require clearing agencies to set standards for all members of their boards of directors or committees (Proposed Rule 17Ad-26); and (7) require all clearing agencies to designate a chief compliance officer (Proposed Rule 3Cj-1).

1. Proposed Rule 17Ad-22(a)

Proposed Rule 17Ad-22(a) contains five definitions. Proposed Rule 17Ad-22(a)(1) would define CCP as a clearing agency that interposes itself between counterparties to securities transactions to act functionally as the buyer to every seller and as the seller to every buyer. Proposed Rule 17Ad-22(a)(2) would define “central securities depository services” to mean services of a clearing agency that is a securities depository as described in Section 3(a)(23) of the Exchange Act.

Proposed Rule 17Ad-22(a)(3) would define “participant”, for the limited purposes of proposed Rules 17Ad-22(b)(3) and 17Ad-22(d)(14), to mean that if a participant controls another participant, or is under common control with another participant, then the affiliated participants shall be collectively deemed to be a single participant. Proposed Rule 17Ad-22(a)(4) would define “normal market conditions”, for the limited purposes of proposed Rules 17Ad-22(b)(1) and (2), to mean conditions in which the expected movement of the price of cleared securities would produce changes in a clearing agency's exposures to its participants that would be expected to breach margin requirements or other risk control mechanisms only one percent of the time. Proposed Rule 17Ad-22(a)(5) would define “net capital”, for the limited purposes of proposed Rule 17Ad-22(b)(7), to have the same meaning as set forth in Rule 15c3-1 under the Exchange Act for broker-dealers or any similar risk adjusted capital calculation for all other prospective clearing members.

[Clearing agency] also means any person, such as a securities depository, who (i) acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry without physical delivery of securities certificates, or (ii) otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates. 15 U.S.C. 78c(a)(23).

As appropriate, the clearing agency would develop risk adjusted capital calculations for prospective clearing members that are not broker-dealers.

The Commission preliminarily believes that these five proposed definitions would be consistent with the common meaning of these terms as understood in the clearance and settlement industry. In addition, the Commission preliminarily believes the definition of “normal market conditions” would be consistent with international use of that term in the context of clearing agency risk management.

The Commission intends for these definitions to provide clearing agencies with appropriate guidance to determine when requirements under proposed Rule 17Ad-22 would apply. The Commission requests comment on the proposed definitions, including whether any additional clarification would be helpful.

In the context of the RCCP, “normal market conditions” means conditions in which the expected movement of the price of cleared securities would produce changes in a clearing agency's exposures to its participants that would be expected to breach margin requirements or other risk control mechanisms only one percent of the time.

See

CPSS Publications

Recommendations for Central Counterparties,

(November 2004),

available at

http://www.bis.org/publ/cpss64.htm.

2. Proposed Rule 17Ad-22(b)

Proposed Rule 17Ad-22(b) would set forth standards that are applicable to clearing agencies that provide CCP services. Specifically, the proposed rule would provide standards with respect to measurement and management of credit exposures, margin requirements, financial resources, and annual evaluations of the performance of the clearing agency's margin models. The proposed rule would also require membership access to clearing agencies for persons that are not dealers or security-based swap dealers, prohibit the use of minimum portfolio size and minimum volume transaction thresholds as a condition for membership at a clearing agency, and permit membership access to a clearing agency by persons with net capital equal to or greater than $50 million. The discussion below provides greater detail regarding each respective standard covered in proposed Rule 17Ad-22(b). The proposed rule is designed to address risks and participant membership structures that are specifically linked to the provision of services associated with a clearing agency interposing itself between counterparties to securities transactions and acting functionally as the buyer to every seller and the seller to every buyer (

i.e.,

CCP services). Accordingly, the Commission preliminarily believes that these requirements would not need to apply to clearing agencies that do not provide CCP services because they would not be engaged in activities that the proposed rule is designed to address.

The Commission preliminarily believes that proposed Rule 17Ad-22(b) would provide standards designed to help ensure sound risk management practices at clearing agencies providing CCP services. Further, the Commission preliminarily believes that the requirements of proposed Rule 17Ad-22(b) would help ensure that the rules, policies and procedures of a clearing agency providing CCP services will be designed to promote fair and open access, to promote the prompt and accurate clearance and settlement of securities transactions, and to assure the safeguarding of securities and funds that are in the custody or control of the clearing agency or for which it is responsible.

Proposed Rule 17Ad-22(b)(1): Measurement and Management of Credit Exposures

Proposed Rule 17Ad-22(b)(1) would require a clearing agency that provides CCP services to establish, implement, maintain and enforce written policies and procedures reasonably designed to measure its credit exposures to its participants at least once each day, and limit its exposures to potential losses from defaults by its participants in normal market conditions

so that the operations of the clearing agency would not be disrupted and non-defaulting participants would not be exposed to losses that they cannot anticipate or control.

See supra

note 36.

The Commission preliminarily believes that measurement and management of credit exposures can, among other things, reduce the likelihood in a participant default scenario that losses from default would disrupt the operations of the clearing agency and its non-defaulting participants and adversely affect the functioning of the clearing agency. A clearing agency providing CCP services faces the risk that its exposures to participants can change dramatically as a result of changes in prices, in positions, or both. Adverse price

movements can rapidly increase exposures to participants, and participants may rapidly change or concentrate their positions through new trading. If not appropriately measured and managed, such results could lead to significant liabilities accruing at the clearing agency.

Recognizing that the risks that clearing agencies are likely to face will change over time, the Commission is proposing that a clearing agency providing CCP services be required to measure its credit exposures to its participants at least once each day. The Commission preliminarily believes this is the minimum frequency of measurement that would permit a clearing agency to effectively consider the risks it faces because of the potential for significant changes to the risk profiles of its participants to change on a daily basis.

In addition to requiring clearing agencies to take steps to measure their credit exposures to participants, the proposed rule would also require clearing agencies to limit their exposures to potential losses from participant defaults. By collecting sufficient margin and having other resources in place to account for losses arising under normal market conditions, the Commission expects that a clearing agency would be able to limit its exposures to potential losses from defaults by its participants. The Commission preliminarily believes that the proposed rule should thereby help ensure prompt and accurate clearance and settlement.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(b)(1). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding measurement and management of credit exposures sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies providing CCP services with respect to measurement and management of credit exposures compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies providing CCP services in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• Should the Commission require clearing agencies acting as CCPs to use any specific confidence level for limiting potential losses under the proposed rule when clearing certain products, or to use minimum amounts of market data when calculating credit exposures? Why or why not?

• What level of discretion should the Commission allow clearing agencies providing CCP services to exercise when measuring and managing credit exposure? Are there circumstances when such discretion should be limited?

• Is it more difficult for clearing agencies providing CCP services and their participants to anticipate and control losses associated with certain types of financial products compared to others? If so, how should the Commission take this into account when establishing rules for clearing agency standards? For example, should the Commission require additional risk management measures to be applied by clearing agencies providing CCP services when judging the risks associated with financial products that trade infrequently or when valuation models for the product are not yet broadly accepted in the financial market? Why or why not?

• Extremely illiquid security-based swap products may be difficult to clear under a conventional CCP clearing model because it may be difficult to value them with a degree of accuracy that allows the CCP to properly manage the risk of those positions. Should the Commission explore developing alternatives to the requirements contained in proposed Rule 17Ad-22(b)(1) based on the liquidity of products a clearing agency clears? What effect would any such requirements have on the potential development of alternative clearing models for highly-illiquid products that would convey some of the benefits of clearing (such as centralized holding of collateral by a third-party custodian, daily adjustment of variation margin amounts, daily posting and return of variation margin, independent valuation of positions, and prompt close-out of positions held by a defaulting market participant)?

• Should the Commission consider requiring clearing agencies that provide CCP services to measure exposures to participants more or less frequently than a minimum of once daily?

Proposed Rule 17Ad-22(b)(2): Margin Requirements

Proposed Rule 17Ad-22(b)(2) would require a clearing agency that provides CCP services to establish, implement, maintain and enforce written policies and procedures reasonably designed to: (i) Use margin requirements to limit its credit exposures to participants in normal market conditions;

(ii) use risk-based models and parameters to set margin requirements; and (iii) review the models and parameters at least monthly.

See supra

note 36.

The Commission preliminarily believes that use of margin requirements by clearing agencies providing CCP services to collect assets (

e.g.,

cash or securities) from its participants as a way to limit exposures to participants in normal market conditions would, among other things, provide the clearing agency with assets it could readily use to limit losses incurred by a participant in the event of a default. By limiting its credit exposure in this manner, a clearing agency providing CCP services would be less likely to be subject to disruptions in its operations as a result of a participant default, thereby promoting prompt and accurate clearance and settlement.

The Commission also preliminarily believes that risk-based models and parameters should be used to set margin requirements because they permit a clearing agency providing CCP services to tailor the amount of margin collected to the needs of the clearing agency. Specifically, models and parameters for collecting margin that account for the risks the clearing agency providing CCP services faces when transacting with a participant may be more likely to result in effective and efficient margin requirements because the level of margin collected would be commensurate with the level of risk presented by the participant to the clearing agency.

In addition, the Commission preliminarily believes that the review of these models and parameters should be required to occur at least monthly. Market conditions and risks are constantly changing and therefore the models and parameters used by a clearing agency providing CCP services to set margin may not accurately reflect the needs of a clearing agency if they are permitted to remain static. The Commission recognizes, however, that there may be benefits to maintaining some stability with respect to margin levels in order to limit operational difficulties. Accordingly, the Commission is proposing that clearing agencies providing CCP services be required to review their models and parameters at least monthly because the Commission preliminarily believes that such time frame would limit the potential that such parameters or models will become stale while also providing the clearing agency flexibility to maintain some stability with respect

to determinations for margin requirements.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(b)(2). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding margin requirements sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies regarding margin requirements compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• Should the Commission require clearing agencies providing CCP services to impose any special margin or intraday margin requirements in certain circumstances? Are there circumstances when special margin or intraday margining would not be appropriate? Why or why not?

• Should the Commission allow clearing agencies providing CCP services to exercise significant discretion when establishing margin practices? Why or why not? Are there circumstances when such discretion should be limited? Is there a risk that clearing agencies providing CCP services may lower margin standards to compete for business? If so, how should the Commission take such factors into account when establishing rules for clearing agencies providing CCP services?

• Should the Commission consider requiring a clearing agency that provides CCP services to review its margin model and parameters more or less frequently than at least monthly?

Proposed Rule 17Ad-22(b)(3): Financial Resources

Proposed Rule 17Ad-22(b)(3) would require a clearing agency that provides CCP services to establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain sufficient financial resources to withstand, at a minimum, a default by the participant to which it has the largest exposure in extreme but plausible market conditions, provided that a security-based swap clearing agency shall maintain sufficient financial resources to withstand, at a minimum, a default by the two participants to which it has the largest exposures in extreme but plausible market conditions.

See

proposed Rule 17Ad-22(a)(3),

supra

Section II.A.1 (defining “participant” for purposes of proposed Rule 17Ad-22(b)(3)).

The Commission preliminarily believes that requiring a clearing agency, other than a security-based swap clearing agency, that provides CCP services to maintain sufficient financial resources to withstand, at a minimum, a default by the participant to which it has the largest exposure in extreme but plausible market conditions would, among other things, reduce the likelihood that a default would create losses that would disrupt the operations of the clearing agency and adversely affect the clearing agency's non-defaulting participants. However, the Commission preliminarily believes that security-based swap clearing agencies that provide CCP services face additional risk-management challenges because of factors unique to the security-based swaps market, such as more limited historical information on pricing and the jump-to-default risk

associated with certain security-based swaps, such as CDS. The Commission preliminarily believes that to promote prompt and accurate clearance and settlement and maintain higher levels of financial resources to account for these risks, it is important for security-based swap clearing agencies that provide CCP services to be able to withstand a default by the two participants to which the clearing agency has its largest exposures in extreme but plausible market conditions. Moreover, the Commission expects that when a clearing agency that provides CCP services determines what level of financial resources would be sufficient to account for exposures in extreme but plausible market conditions, the clearing agency would consider potential losses that would be greater than those resulting from observed periods of significant volatility or disturbances.

Jump-to-default risk relates to the possibility of a reference entity unexpectedly experiencing a credit event over a short period resulting in significant changes in the value of any CDS contracts written on that particular reference entity. For example, a seller of a CDS could be collecting regular premiums with little expectation that the reference entity may default. However, if that reference entity suddenly experiences a credit event, it will trigger an unexpected obligation on the protection seller to pay a lump sum, dependent on the size of the contract, to the protection buyer.

See generally

Darrell Duffie and Haoxiang Zhu,

Does a Central Clearing Counterparty Reduce Counterparty Risk?

(Stanford Univ. 2010),

available at

http://www.stanford.edu/~duffie/DuffieZhu.pdf.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(b)(3). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding requiring clearing agencies providing CCP services to maintain sufficient financial resources sufficiently clear? If not, why not and what would be a better alternative?

• Should the Commission require all clearing agencies providing CCP services, instead of only those clearing security-based swaps, to maintain sufficient financial resources to withstand a default by the two participants to which it has the largest exposures in extreme but plausible market conditions? Should all or any subset of clearing agencies be required to maintain sufficient financial resources based on more or less than two participant defaults? For example, should the financial resources requirements be different for certain clearing agencies, such as security-based swap clearing agencies or those designated as systemically important under the Clearing Supervision Act? Should the Commission require that financial resources be measured based on a different standard than resources needed to withstand default by a certain number of participants, such as a percentage of the total business conducted by the clearing agency?

• How do current practices of clearing agencies pertaining to financial resources compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• Are the financial resources standards for clearing agencies providing CCP services proposed by the Commission sufficient for the proper functioning of a clearing agency? Should a clearing agency providing CCP services be able to mutualize losses during a default using financial resources designed to cover price movements? Should the Commission establish more specific rules? For example, should the Commission establish standards for the level of clearing agency resources maintained in a guarantee fund as opposed to a margin fund, or should clearing agencies providing CCP services be given discretion to manage the composition of their financial resources as they see fit? Why or why not? Should the Commission establish more prescriptive requirements concerning the financial resources of certain clearing agencies providing CCP services, such as those

that clear security-based swaps or those that are designated as systemically important under the Clearing Supervision Act?

• Should the Commission provide additional guidance regarding what constitutes “extreme but plausible market conditions”? Does allowing clearing agencies providing CCP services discretion to interpret this term create uncertainty or introduce more risk into the financial system than might otherwise be the case?

• What are clearing agencies' providing CCP services and their participants' incentives to maintain financial resources to withstand the foreseeable consequences of participant defaults? Are there identifiable circumstances in which these self-interested incentives may vary? For example, do clearing agencies providing CCP services with public shareholders have different incentives than clearing agencies providing CCP services that are member-owned? Can the capital structure of the clearing agency providing CCP services and the order in which losses are suffered by defaulting parties, surviving participants and any public shareholders affect the level of risk accepted by the clearing agency? If so, how should the Commission take these factors into account when establishing rules for clearing agencies providing CCP services?

Proposed Rule 17Ad-22(b)(4): Model Validation

Proposed Rule 17Ad-22(b)(4) would require a clearing agency that provides CCP services to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for an annual model validation process consisting of evaluating the performance of the clearing agency's margin models and the related parameters and assumptions associated with such models by a qualified person who does not perform functions associated with the clearing agency's margin models (except as part of the annual model validation) and does not report to a person who performs these functions.

Any person responsible for supervising the operation of the clearing agency's margin model would be viewed as performing the functions associated with the clearing agency's margin model and could not therefore have supervisory authority over the person conducting the model validation.

The Commission preliminarily believes that clearing agencies that provide CCP services need to have a qualified person conduct a review of models that are used to set margin levels, along with related parameters and assumptions, in order to assure that the models perform in a manner that facilitates prompt and accurate clearance and settlement of transactions. In determining whether a person is qualified to conduct the model validation, clearing agencies providing CCP services could consider several factors, including the person's experience in validating margin models, expertise in risk management generally, and understanding of the clearing agency's operations and procedures.

In addition, the Commission is proposing that the person conducting the model validation be a person who does not perform functions associated with the clearing agency's margin models (except as part of the annual model validation) and does not report to a person who performs these functions. The Commission preliminarily believes that a review by a person who is not involved in the day-to-day operation of the margin model is important to identify potential vulnerabilities or limitations and to promote a critical evaluation of the model. This is because a person involved in the functions related to the model's operation, or someone who reports to such a person, may be less likely to critically evaluate the margin model because of preconceived views or a desire not to find issues with a model that they help to operate.

The Commission preliminarily believes that the person validating the clearing agency's margin model should be sufficiently free from outside influences so that he or she can be completely candid in their assessment of the model.

Proposed Rule 17Ad-22(b)(4), however, would not prevent a person conducting the model validation from being employed by the clearing agency if the conditions in the proposed rule are satisfied. For example, a qualified member of the internal audit function that operates under a separate reporting line may be able to provide the model validation.

Finally, the Commission is proposing that the model validation be conducted on an annual basis. The Commission preliminarily believes that conducting the model validation on an annual basis would provide a sufficiently frequent evaluation period because model performance ordinarily would not be expected to vary significantly over short periods but should be re-evaluated as market conditions change.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(b)(4). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule requiring clearing agencies to provide for a model validation sufficiently clear? If not, why not and what would be a better alternative?

• What are the advantages and disadvantages of requiring an annual model validation? Should a more or less frequent model validation be required? Should the model validation be specifically triggered as a result of any material change in the clearing agency, such as the introduction of new products or the addition of portfolio margining arrangements with other clearing agencies?

• Should the Commission place more or less stringent restrictions on the type of person who is permitted to conduct the model validation? For example, should the Commission prescribe any specific qualifications that the person conducting the model validation should have? Should the Commission require an outside consultant be engaged to conduct the model validation? Should persons that perform functions associated with the clearing agency's margin model be able to conduct the model validation?

• Does the proposal provide sufficient or excessive separation of the person conducting the model validation from the persons who develop and administer the model? In either case, please explain. Should the Commission adopt additional requirements to help ensure that the persons conducting the model validation are free from retaliation and influence? If so, please explain. What costs or burdens might such additional requirements impose on the effective validation of models?

Proposed Rule 17Ad-22(b)(5): Non-Dealer Member Access

Proposed Rule 17Ad-22(b)(5) requires a clearing agency that provides CCP services to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide the opportunity for a person that does not perform any dealer

or security-based swap dealer

services to

obtain membership on fair and reasonable terms at the clearing agency in order to clear securities for itself or on behalf of other persons. Dealer and security-based swap dealer services generally involve services designed to facilitate securities transactions by buying and selling securities for a person's own account. The Commission preliminarily believes that requiring clearing agencies that perform CCP services to allow persons who are not dealers or security-based swap dealers to become members of the clearing agency will promote more competition in and access to clearing through facilitating indirect clearing arrangements, commonly referred to as correspondent clearing. Correspondent clearing is an arrangement between a current participant of a clearing agency and a non-participant that desires to use the clearing agency for clearance and settlement services.

The term “dealer” is defined in Section 3(a)(5) of the Exchange Act and means any person engaged in the business of buying and selling securities for such person's own account through a broker or otherwise. The definition contains an exception for a person that buys or sells securities for such person's own account, either individually or in a fiduciary capacity, but not as a part of a regular business. There is also an exception for banks engaging in certain specified activities.

See

15 U.S.C. 78c(a)(5) for the complete definition.

Pursuant to Section 761 of the Dodd-Frank Act, the term “security-based swap dealer” is added as Section 3(a)(71) of the Exchange Act, 15 U.S.C. 78c(a), and generally means any person who (A) holds itself out as a dealer in security-based swaps; (B) makes a market in security-based swaps; (C) regularly enters into security-based swaps with counterparties as an ordinary course of business for

its own account; or (D) engages in any activity causing it to be commonly known in the trade as a dealer or market maker in security-based swaps.

See

Public Law 111-203, Section 761 for the complete definition.

See also

Exchange Act Release No. 63452 (December 7, 2010), 75 FR 80174 (December 21, 2010),

supra

note 4.

The Commission has previously noted that in situations where direct access to clearing agencies is limited by reasonable participation standards firms that do not meet these standards may still be able to access clearing agencies through correspondent clearing arrangements with direct participants.

Such a process would involve the non-participant entering into a correspondent clearing arrangement with a participant so that the transaction may be submitted by the participant to the clearing agency. Thus, the success of correspondent clearing arrangements depends on the willingness of participants to enter into such arrangements with non-participant firms which may act as direct competitors to the participants in the participants' capacity as dealers or security-based swap dealers in the market for buying or selling the relevant securities. Given that participants that are dealers or security-based swap dealers may have an incentive to restrict clearing access to potential competitors, correspondent clearing arrangements may not be readily established without providing participants that do not provide dealer or security-based swap dealer services with the ability to become members of a clearing agency and thereby help develop correspondent clearing arrangements.

See

Exchange Act Release No. 63107 (October 14, 2010), 75 FR 65882 (October 26, 2010) (Ownership Limitations and Governance Requirements for Security-Based Swap Clearing Agencies, Security-Based Swap Execution Facilities, and National Securities Exchanges with Respect to Security-Based Swaps under Regulation MC).

At the same time, the Commission recognizes that persons who are not dealers or security-based swap dealers may fail to meet other standards for membership at a clearing agency, such as the operational capabilities required for direct participation. Proposed Rule 17Ad-22(b)(5) would not prohibit clearing agencies that provide CCP services from taking these factors into account when establishing membership criteria for non-dealers. Rather, the proposal would prohibit clearing agencies that provide CCP services from denying membership on fair and reasonable terms to otherwise qualified persons solely by virtue of the fact that they do not perform any dealer or security-based swap dealer services.

The Commission preliminarily believes that the incentives of persons who do not provide dealer or security-based swap dealer services to promote access at the clearing agency that provides CCP services would not be limited by a desire to restrict competition in the market for buying or selling the relevant securities. Accordingly, the Commission preliminarily believes that permitting such persons to become members of a clearing agency that provides CCP services may foster the development of correspondent clearing arrangements that would allow dealers and security-based swap dealers, who may otherwise not be able to meet reasonable participation standards of a clearing agency, to obtain access to the clearing agency through correspondent clearing arrangements. The Commission preliminarily believes this would be beneficial because it could result in greater competition in and access to clearing.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(b)(5). In addition, the Commission requests comments on the following specific issues:

• In addition to prohibiting denial of membership based on whether a person provides dealer or security-based swap dealer services as a way to facilitate greater indirect access to clearing, should the Commission consider other measures to promote access to clearing at clearing agencies that provide CCP services, including any requirements designed to promote greater direct access to clearing (

e.g.,

adding specific membership categories)?

• Should clearing agencies that provide CCP services be required to have policies and procedures that are designed to promote membership by non-dealers? If so, what would be the advantages and disadvantages of requiring the clearing agency to periodically measure its performance against the objectives contained in such policies and procedures, and who within the clearing agency should be responsible for conducting such a review (for instance the chief compliance officer)?

• Is the Commission's proposed rule requiring clearing agencies that provide CCP services to provide the opportunity for a person that does not perform any dealer or security-based swap dealer services to obtain membership at the clearing agency to clear securities for itself or on behalf of other persons sufficiently clear? If not, why not?

• Should the Commission consider more prescriptive regulations to specify the criteria that clearing agencies should use to grant membership privileges to persons that do not perform any dealer or security-based swap dealer services to clear securities for themselves or on behalf of other persons? Please explain why or why not.

• What are the potential advantages and disadvantages of having persons that do not provide dealer or security-based swap dealer services as members of a clearing agency?

• If a clearing agency that provides CCP services does not have rules that facilitate correspondent clearing, should the Commission consider requiring that clearing agency to justify to the Commission why its rules do not facilitate correspondent clearing? What would be the advantages and disadvantages of such a requirement? What are the potential reasons why a clearing agency may not have rules that facilitate correspondent clearing arrangements?

• Should the Commission consider limiting the proposed requirement for providing membership access to persons who do not provide dealer or security-based swap dealer services to a certain category of clearing agencies, such as security-based swap clearing agencies that provide CCP services or those designated as systemically important? Please explain why or why not. In particular, are there special considerations, such as market concentration, affecting security-based swap clearing agencies that provide CCP services that make access to those clearing agencies for non-dealers particularly important? If not, why not? If so, what are those considerations and how would this requirement address

them? Do any similar considerations exist, or is there a potential that similar considerations could exist in the future, with respect to clearing agencies that clear securities other than security-based swaps? Would there be any advantages or disadvantages to maintaining one standard for all clearing agencies that provide CCP services? Please explain.

Proposed Rule 17Ad-22(b)(6): Portfolio Size and Transaction Volume Thresholds Restrictions

Proposed Rule 17Ad-22(b)(6) prohibits a clearing agency that provides CCP services from having membership standards that require that participants maintain a portfolio of any minimum size or that participants maintain a minimum transaction volume. The Commission notes that the proposed rule would not prohibit a clearing agency that provides CCP services from considering portfolio size and transaction volume as one of several factors when reviewing a potential participant's operations. Rather, the proposed rule would prohibit the establishment of minimum portfolio sizes or transaction volumes that by themselves would act as barriers to participation by new participants in clearing. Such minimum thresholds would not function as a good indicator of whether a participant is able to meet its obligations to a clearing agency.

This is because new participants to a clearing agency that provides CCP services that do not initially intend to transact in substantial size or volume may nevertheless have the operational and financial capacity to perform the activities that other participants are able to perform. Therefore, the Commission preliminarily believes that the proposed rule may help to facilitate the requirement in Section 17A of the Exchange Act that the rules of a clearing agency permit fair and open access.

Proposed Rule 17Ad-22(b)(6) would not prohibit a clearing agency from imposing maximums portfolio sizes or transaction volume amounts.

See infra

note 59.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(b)(6). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule prohibiting clearing agencies that provide CCP services from having membership standards that require participants to maintain a portfolio of any minimum size or to meet a minimum transaction volume threshold sufficiently clear? If not, why not?

• What are the potential advantages and disadvantages of prohibiting clearing agency membership standards from requiring participants to maintain a minimum portfolio size or meet a minimum transaction volume threshold? Please explain.

• Should the Commission consider imposing the proposed requirements on all clearing agencies, rather than only those that provide CCP services? Why or why not?

• Should the Commission consider prohibiting only security-based swap clearing agencies that provide CCP services from having membership standards that require participants to maintain a minimum portfolio size or to maintain a minimum transaction volume? Please explain why or why not. In particular, are there special considerations affecting security-based swap clearing agencies that provide CCP services that make it particularly important to prevent use of these specific criteria in their membership standards? If so, what are those special considerations and how would this requirement address them? If not, in what ways would such a requirement impact the operations of security-based swap clearing agencies that provide CCP services and other types of clearing agencies? Would there be advantages to maintaining one standard for all clearing agencies that provide CCP services? Why or why not?

Proposed Rule 17Ad-22(b)(7): Net Capital Restrictions

Proposed Rule 17Ad-22(b)(7) requires a clearing agency that provides CCP services to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide a person that maintains net capital

equal to or greater than $50 million with the opportunity to obtain membership at the clearing agency, with any net capital requirements being scalable so that they are proportional to the risks posed by the participant's activities to the clearing agency. This means that while a clearing agency that provides CCP services could not restrict access to the clearing agency solely because a participant does not have a net capital level above $50 million, the clearing agency's policies and procedures could be reasonably designed to limit the activities of the participant in comparison to the activities of other participants that maintained a higher net capital level. For example, as a way to help make its requirements scalable, a clearing agency may elect to place limits on its potential exposure to participants operating at certain net capital thresholds by restricting the maximum size of the portfolio such participants are permitted to maintain at the clearing agency. The Commission preliminarily believes that persons that maintain a net capital level of $50 million would have sufficient net capital to be able to participate at some level in a clearing agency that provides CCP services, provided that they are able to comply with other reasonable membership standards. Based on broker-dealer reporting data available to the Commission, the $50 million threshold for net capital is a standard that only approximately 4% of the total number of broker-dealers could satisfy. Accordingly, the Commission preliminarily believes that prohibitions on membership access that are based solely on persons having net capital equal to or greater than $50 million could introduce unnecessary barriers to clearing access. The Commission also preliminarily believes that the proposed rule would facilitate sound risk management practices by the clearing agencies by encouraging the clearing agencies to examine and articulate the benefits of higher net capital requirements as a result of having clearing agencies develop scalable membership standards that link the nature and degree of participation with the potential risks posed by the participant.

Proposed Rule 17Ad-22(a)(5) would define “net capital”, for the limited purposes of proposed Rule 17Ad-22(b)(7), to have the same meaning as set forth in Rule 15c3-1 under the Exchange Act for broker-dealers or any similar risk adjusted capital calculation for all of other prospective clearing members.

The Commission notes there are examples of capital-related requirements that differentiate among types of participants. For instance, the Fixed Income Clearing Corporation has maintained a $50 million net worth requirement and $10 million excess net capital requirement for its Category 1 Dealer Netting Members and a $25 million net worth requirement and $10 million excess net capital requirement for its Category 2 Dealer Netting Members.

Proposed Rule 17Ad-22(b)(7) also permits a clearing agency to provide for a higher net capital requirement (

i.e.,

higher than $50 million) as a condition for membership at the clearing agency if the clearing agency demonstrates to the Commission that such a requirement is necessary to mitigate risks that could not otherwise be effectively managed by other measures, such as scalable limitations on the transactions that the participants may clear through the clearing agency, and the Commission approves the higher net capital requirement as part of a rule filing or

clearing agency registration application. The Commission preliminarily believes that by providing a method for clearing agencies to impose higher net capital requirements in circumstances where such requirements are necessary to mitigate risks, the proposed rule would provide appropriate flexibility for risk management purposes.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(b)(7). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule limiting the ability of clearing agencies that provide CCP services to deny membership access to participants with $50 million or more in net capital sufficiently clear? If not, why not?

• What are advantages or disadvantages of requiring a clearing agency that provides CCP services to provide a person that maintains a net capital equal to or greater than $50 million with the ability to obtain membership at the clearing agency, with any net capital requirements being scalable so that they are proportional to the risks posed by the participant's activities to the clearing agency?

• Should the Commission consider a higher or lower threshold for net capital than the proposed $50 million amount? Please explain and describe the rationale for the desired threshold amount.

• Should the Commission consider providing for the adjustment of the $50 million net capital threshold to reflect inflation, deflation or other factors? If so, how should the Commission make such adjustment?

• Would access to clearing agencies that provide CCP services by dealers or security-based swap dealers that are not currently members of such clearing agencies be significantly improved as a result of the proposed requirement?

• Are there any difficulties that clearing agencies that provide CCP services may encounter in implementing a system that seeks to scale net capital to the risk that a participant brings to a clearing agency? Would clearing agencies be able to effectively model such risks to prevent the potential of significant losses above the amounts of margin collected? How would clearing agencies seek to limit the activities of participants to prevent the risk of significant losses above the amounts of margin collected?

• Does the proposal, to permit a clearing agency to provide for a higher net capital requirement (

i.e.,

higher than $50 million) as a condition for membership at the clearing agency if the clearing agency demonstrates to the Commission that such a requirement is necessary to mitigate risks that could not otherwise be effectively managed by other measures, provide sufficient flexibility to be able to address potential risk management concerns? Would the proposal lead to higher or lower levels of risk at clearing agencies? Please explain.

• Should the Commission consider requiring only security-based swap clearing agencies that provide CCP services to be subject to this requirement? Please explain why or why not. In particular, are there special considerations affecting security-based swap clearing agencies that provide CCP services, such as market concentration, that make it particularly important for a person that maintains net capital equal to or greater than $50 million to have the ability to obtain membership? If so, what are those special considerations and how would this requirement address them? If not, in what ways would this requirement impact the operations of security-based swap clearing agencies that provide CCP services and other clearing agencies? Would there be any advantages or disadvantages to maintaining one requirement for all clearing agencies that provide CCP services? Please explain.

3. Proposed Rule 17Ad-22(c)

Proposed Rule 17Ad-22(c)(1) would provide that each fiscal quarter (based on calculations made as of the last business day of the clearing agency's fiscal quarter), or at any time upon Commission request, a clearing agency that performs central counterparty services shall calculate and maintain a record

of the financial resources necessary to meet its requirement in proposed Rule 17Ad-22(b)(3) and sufficient documentation to explain the methodology it uses to compute such financial resource requirement.

See

Exchange Act Rule 17a-1 (17 CFR 240.17a-1). Clearing agencies may destroy or otherwise dispose of records at the end of five years consistent with Exchange Act Rule 17a-6 (17 CFR 240.17a-6).

The Commission preliminarily believes that it would be appropriate to require clearing agencies that provide CCP services to make these calculations quarterly or at any time based on the request of the Commission because this proposed requirement would provide a periodic update of the financial resources that are needed as market conditions change, while also providing flexibility for the Commission to request such calculations on a real-time basis, which may be useful during periods of market stress or other circumstances where more timely information is desired. These calculations and related documentation should help the Commission in its oversight of clearing agencies' compliance with proposed Rule 17Ad-22(b)(3) by providing a clear record of the method used by the clearing agency providing CCP services to maintain sufficient financial resources.

Proposed Rule 17Ad-22(c)(2) would require a clearing agency to post on its Web site an annual audited financial report. Each financial report would be required to (i) be a complete set of financial statements of the clearing agency for the most recent two fiscal years of the clearing agency and be prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”), except that for a clearing agency that is a corporation or other organization incorporated or organized under the laws of any foreign country, the financial statements may be prepared according to U.S. GAAP or International Financial Reporting Standards as issued by the International Accounting Standards Board (“IFRS”); (ii) be audited in accordance with standards of the Public Company Accounting Oversight Board by a registered public accounting firm that is qualified and independent in accordance with Rule 2-01 of Regulation S-X (17 CFR 210.2-01); and (iii) include a report of the registered public accounting firm that complies with paragraphs (a) through (d) of Rule 2-02 of Regulation S-X (17 CFR 210.2-02). The Commission preliminarily believes that requiring the posting of the clearing agency's audited annual financial report would provide an additional layer of information about the activities and financial strength of the clearing agency that market participants may find useful in assessing their use of the clearing agency's services.

The requirements of proposed Rule 17Ad-22(c)(2) concerning the audited annual financial report would apply individually to each respective clearing agency.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(c). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding calculating and maintaining a record of the financial resources necessary pursuant to proposed Rule 17Ad-22(b)(3) sufficiently clear? If not,

why not and what would be a better alternative?

• How do current practices by clearing agencies providing CCP services compare to the practices that the Commission proposes requiring in this rule with respect to determining needed financial resources? What are the expected incremental costs to clearing agencies that provide CCP services in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• Should the Commission require calculation of the financial resources related information more or less frequently than quarterly? Why or why not?

• Should the Commission require any other financial statements of a clearing agency to be posted on its Web site, such as quarterly financial statements?

• What are the advantages and disadvantages of permitting a financial report to be in compliance with IFRS as an alternative to U.S. GAAP? If the Commission adopts the proposal to permit certain clearing agencies to report using IFRS as published by the IASB, should the Commission require a reconciliation to U.S. GAAP for specified accounts? If so, what accounts or items would be most useful to participants and other regulators? Would permitting only clearing agencies that are incorporated or organized under the laws of any foreign country to report under IFRS create any incentives for changing jurisdictions of incorporation or organization? If it is permitted, should we exclude certain clearing agencies, such as those who fall within one or more of the following categories: (i) Those whose financial reports have not been audited by an independent public accountant inspected by the PCAOB, (ii) those who have not received a “clean” audit opinion, or (iii) those who have previously had to correct a material error in their financial statements?

4. Proposed Rule 17Ad-22(d)

Proposed Rule 17Ad-22(d) would set forth certain standards that relate to clearance and settlement processes. The areas addressed include: (1) Transparent and enforceable rules and procedures; (2) participation requirements; (3) custody of assets and investment risk; (4) operational risk; (5) money settlement risk; (6) cost-effectiveness; (7) links; (8) governance; (9) information on services; (10) immobilization and dematerialization of stock certificates; (11) default procedures; (12) timing of settlement finality; (13) delivery versus payment; (14) risk controls to address participants' failures to settle; and (15) physical delivery risks. The discussion below provides greater detail regarding each respective standard covered in proposed Rule 17Ad-22(d).

Proposed Rule 17Ad-22(d)(1): Transparent and Enforceable Rules and Procedures

Proposed Rule 17Ad-22(d)(1) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for a well founded, transparent and enforceable (legally and practically) structure for each aspect of their activities in all relevant jurisdictions.

The clearing agency should have written policies and procedures

in place that, at a minimum, address the significant aspects of a clearing agency's operations and risk management in order to provide a well founded legal framework and must be clear, internally consistent, and readily accessible by the public in order to provide a transparent legal framework. In addition, the clearing agency must be able to enforce its policies and procedures that contemplate enforcement by the clearing agency. Moreover, policies and procedures that govern or create remedial measures that a party other than the clearing agency (such as a clearing member) can undertake to seek redress or to promote compliance with applicable rules must be enforceable.

For the clearing agency's policies and procedures to be enforceable, a clearing agency must have appropriate means to compel parties to comply in a timely manner, including members or service providers of clearing agencies that are non-U.S. persons. The Commission preliminarily believes this proposed requirement would help to reduce the legal risks involved in the clearance and settlement process. Such legal risks include, among other things, the likelihood that the policies and procedures of a clearing agency are incomplete, opaque, or not enforceable and will therefore adversely affect the functioning of the clearing agency.

Because they would function to reduce these legal risks, the Commission preliminarily believes that well founded, transparent and enforceable policies and procedures established by the clearing agency to underpin the clearing agency's operational and business activities are essential to a clearing agency's ability to facilitate the prompt and accurate clearance and settlement of securities transactions and safeguard securities and funds as required for the protection of investors by Section 17A of the Exchange Act.

A relevant jurisdiction would include, among others, activities (i) in the United States, (ii) involving any means of interstate commerce, or (iii) in respect to providing clearing services to any U.S. person. For clearing agencies that operate in multiple jurisdictions, this also could include resolving possible conflicts of laws issues that the clearing agency may encounter.

Clearing agencies are SROs as defined in Section 3(a)(26) of the Exchange Act. A stated policy, practice, or interpretation of an SRO, such as a clearing agency's written policies and procedures, would generally be deemed to be a proposed rule change.

See

17 CFR 240.19b-4.

The Commission preliminarily believes that proposed Rule 17Ad-22(d)(1) would augment the Exchange Act requirement that the rules of the clearing agency must provide that its participants shall be appropriately disciplined for any violation of any provision of the rules of the clearing agency.

See

15 U.S.C. 78q-1(b)(3)(G).

See generally,

RSSS Recommendation 1, Legal Framework and RCCP Recommendation 1, Legal Risk.

15 U.S.C. 78q-1(a)(1)(A).

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(1). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding policies and procedures providing for a well founded, transparent, and enforceable legal framework sufficiently clear? If not, why not? Is there a better alternative?

• How would this proposal affect the current practices of clearing agencies in formulating policies and procedures? Would the proposed rule affect the costs of providing clearing agency services? Please explain.

• What are the advantages and disadvantages of taking into account that legal risks may vary by the types of services offered by clearing agencies and whether the clearing agency operates in multiple jurisdictions? Are there any considerations, such as issues concerning compliance with regulations under various jurisdictions, that the Commission should take into account for clearing agencies operating in multiple jurisdictions?

• Should the Commission consider more prescriptive rules to define how clearing agencies would provide for a well founded, transparent and enforceable legal framework? Please explain why or why not. Alternatively, should the Commission consider more prescriptive rules that would apply in the context of approval of a clearing agency's application for registration?

• Should the Commission require a clearing agency to submit legal opinions or other supporting evidence to demonstrate the legal adequacy of the mechanisms at the clearing agency that

are in place to handle participant defaults?

Proposed Rule 17Ad-22(d)(2): Participation Requirements

Proposed Rule 17Ad-22(d)(2) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to require participants to have sufficient financial resources and robust operational capacity to meet obligations arising from participation in the clearing agency. This proposed requirement is intended to reduce the likelihood of defaults by participants, while also providing flexibility to tailor standards that are linked to the obligations of the participant. As a result, the Commission preliminarily believes this requirement would protect investors and facilitate prompt and accurate clearance and settlement by promoting membership standards at clearing agencies that are likely to limit the potential for defaults.

The proposed rule also would require clearing agencies to have procedures in place to monitor that participation requirements are met on an ongoing basis. Operational and financial stability of participants is subject to market forces and can therefore change over time. Because participants collectively contribute to the operational and financial stability of a clearing agency, the Commission preliminarily believes that the proposed requirement to continue to monitor compliance with the clearing agency's participation requirements supports the Exchange Act requirement that clearing agencies are able to facilitate prompt and accurate clearance and settlement.

15 U.S.C 78q-1(b)(3)(A).

In addition, clearing agencies would be required to have participation requirements that are objective,

publicly disclosed, and facilitate fair and open access.

The Commission preliminarily believes this requirement would foster compliance with the requirement under Section 17A of the Exchange Act that the rules of a clearing agency must not be designed to permit unfair discrimination in the admission of participants by requiring standards that are designed to be measurable, open and fair.

Objective criteria would generally include, but not be limited to, criteria that are based on measureable facts such as capital requirements.

Having open access, in part, involves having a process for admission of participants that does not unfairly discriminate.

See

15 U.S.C. 78q-1(b)(3)(F) (“The rules of a clearing agency * * * are not designed to permit unfair discrimination in the admission of participants or among participants in the use of the clearing agency”). In addition, the Dodd-Frank Act added Section 3C to the Exchange Act which provides in relevant part: “(2) OPEN ACCESS.—The rules of a clearing agency described in paragraph (1) shall— (A) prescribe that all security-based swaps submitted to the clearing agency with the same terms and conditions are economically equivalent within the clearing agency and may be offset with each other within the clearing agency; and (B) provide for non-discriminatory clearing of a security-based swap executed bilaterally or on or through the rules of an unaffiliated national securities exchange or security-based swap execution facility.” Public Law 111-203 § 763(a) (adding Section 3C to the Exchange Act).

15 U.S.C. 78q-1(b)(3)(F).

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(2). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding participation requirements sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of registered clearing agencies with respect to participation standards compare to the proposed requirements in this rule? Are there any expected costs or benefits to clearing agencies in connection with adding to or revising their participation standards in order to implement this portion of the Commission's proposed rule?

• Should the Commission's proposed rule regarding participation requirements be more specific? If so, why and in what way? Should the Commission's proposed rule regarding participation requirements be less specific to allow for greater flexibility? If so, why and in what way?

• Should more specific monitoring obligations be imposed to ensure compliance with participation standards? For example, should the Commission consider mandating an independent review of the process for monitoring participants' compliance with the clearing agency's participation requirements? Why or why not?

Proposed Rule 17Ad-22(d)(3): Custody of Assets and Investment Risk

Proposed Rule 17Ad-22(d)(3) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to hold assets in a manner whereby risk of loss or of delay in access to them is minimized. Minimizing the risk of loss or delay in access is intended to refer to holding assets in ways that, to the extent reasonably practicable, would limit the potential for loss of those assets and delay in access to them. For example, the Commission is aware that clearing agencies currently seek to minimize the risk of loss or delay in access by holding assets that are highly-liquid (

e.g.,

cash, U.S. Treasury securities or securities issued by a U.S. government agency) and engaging banks to custody the assets and facilitate settlement. Compliance with the proposed requirement is intended to improve the ability of the clearing agency to meet its settlement obligations by reducing the likelihood that assets securing participant obligations to the clearing agency would be unavailable or insufficient when the clearing agency needs to draw on them. The proposed rule would also require clearing agencies to invest assets in instruments with minimal credit, market, and liquidity risks. A requirement that a clearing agency hold assets in instruments with minimal credit, market and liquidity risk may promote the clearing agency's ability to retrieve these assets promptly. That, in turn, could help to increase the potential for a clearing agency to timely meet its settlement obligations to its participants.

The Commission preliminarily believes that proposed Rule 17Ad-22(d)(3) would strengthen the requirement in Section 17A(b)(3)(F) of the Exchange Act that the rules of a clearing agency must be designed to ensure the safeguarding of securities and funds in the custody or control of the clearing agency or for which the clearing agency is responsible.

In this way, the Commission preliminarily believes the proposed rule would also promote protection of the financial market served by the clearing agency.

15 U.S.C. 78q-1(b)(3)(F).

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(3). In addition, the Commission requests comments on the following specific issues:

• Are the proposed rule's requirements regarding custody and investment of assets sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies for holding or investing in assets compare to the Commission's proposal? What are the expected incremental costs to clearing agencies in connection with adding to or revising these current practices in order to comply with the Commission's proposed rule?

• Are there any other factors not mentioned that the Commission should take into consideration with respect to

minimizing custody of assets and investment risk?

• Should clearing agencies ever be permitted to hold assets in instruments that do not have minimal credit, market and liquidity risk? If so, why and under what circumstances?

• What measures should clearing agencies have in place to minimize risk of loss or delay in access to assets? Should the proposed rule specify any such measures?

Proposed Rule 17Ad-22(d)(4): Identification and Mitigation of Operational Risk

Proposed Rule 17Ad-22(d)(4) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to identify sources of operational risk and minimize these risks through the development of appropriate systems, controls, and procedures. A clearing agency that develops systems, controls and procedures which, taken as a whole, are designed to limit the identified sources of operational risk to the extent reasonably practicable would be able to satisfy this requirement. The proposed rule also would require clearing agencies to implement systems that are reliable, resilient and secure and have adequate scalable capacity. This should help to ensure that clearing agencies are able to operate with minimal disruptions, even during times of market stress when there may be greater demands on their systems due to higher volume. In addition, the proposed rule would require that clearing agencies have business continuity plans that allow for timely recovery of operations and ensure the fulfillment of a clearing agency's obligations. This requirement would be relevant in the event of, among other things, deficiencies in information systems or internal controls, human errors, management failures, unauthorized intrusions into corporate or production systems, or disruptions from external events such as natural disasters.

The Commission preliminarily believes that the requirements under proposed Rule 17Ad-22(d)(4) should collectively help to address risks posed by potential operational deficiencies to the clearing agency and its participants. Specifically, to help limit disruptions that may impede the proper functioning of a clearing agency, the Commission preliminarily believes it is imperative that clearing agencies review their operations for potential weaknesses and develop appropriate systems, controls, and procedures to address weaknesses contemplated under the proposed rule. Moreover, the Commission preliminarily believes that maintaining reliable, resilient and secure systems with adequate backup capability, as well as continuity plans providing for timely recovery of operations, are essential components of facilitating prompt and accurate clearance and settlement. The Commission intends for proposed Rule 17Ad-22(d)(4) to complement the existing guidance provided by the Commission in its Automation Review Policy statements

and Interagency White Paper on Sound Practices to Strengthen the Resilience of the U.S. Financial System.

See

Exchange Act Release Nos. 27445 (November 16, 1989), 54 FR 48704 (“ARP I”) and 29815 (May 9, 1991), 56 FR 22489 (“ARP II”). Generally, the guidance in ARP I and ARP II provides for the following activities by clearing agencies: (1) Performing periodic risk assessments of its automated data processing (“ADP”) systems and facilities; (2) providing for the selection of the clearing agency's independent auditors by non-management directors and authorizing such non-management directors to review the nature, scope, and results of all audit work performed; (3) having an adequately staffed and competent internal audit department; (4) furnishing annually to participants audited financial statements and an opinion from an independent public accountant as to the clearing agency's system of internal control—including unaudited quarterly financial statements also should be provided to participants upon request; and (5) developing and maintaining plans to assure the safeguarding of securities and funds, the integrity of the ADP system, and recovery of securities, funds, or data under a variety of loss or destruction scenarios.

See

Exchange Act Release No. 47638 (April 7, 2003), 68 FR 17809 (April 11, 2003),

available at http://www.sec.gov/news/studies/34-47638.htm.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(4). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding identification and mitigation of operational risk sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies with respect to operational risks compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices relating to operational risks in order to implement the Commission's proposed rule?

• Should the Commission's proposal require a specific methodology to identify and mitigate operational risk? If so, what is the methodology and why should this methodology be required?

• Should the Commission require that business continuity plans be tested with participants on an ongoing basis or with a specified frequency? Should any other more prescriptive requirements be considered by the Commission?

• Would a clearing agency's ability to comply with the proposed rule be affected if the clearing agency's operations were outsourced to another firm? If so, how should the proposed rule address these differences in compliance? Would the need to minimize operational risk require limits on the types of operations that can be outsourced by clearing agencies? Would the answer depend on whether the function was outsourced to an affiliated or unaffiliated firm? Please explain.

Proposed Rule 17Ad-22(d)(5): Money Settlement Risks

Proposed Rule 17Ad-22(d)(5) would require clearing agencies establish, implement, maintain and enforce written policies and procedures reasonably designed to employ money settlement arrangements that eliminate or strictly limit the clearing agency's settlement bank risks, that is, its credit and liquidity risks from the use of banks to effect money settlements with its participants, and require funds transfers to the clearing agency to be final when effected. The Commission notes that there are a number of arrangements that clearing agencies could establish to comply with the proposed rule. For example, a clearing agency could establish criteria for use of banks to effect money settlements with its participants that address the banks' creditworthiness, access to liquidity, and operational reliability. Where practicable, a clearing agency could use multiple settlement banks and monitor the concentration of payments among its settlement banks. A clearing agency also could employ agreements with such banks to ensure that funds transfers to the clearing agency are final when effected. In addition, where available, a clearing agency could use a central bank to effect money settlements with its participants. Use of the Federal Reserve System in the United States or other central bank would eliminate the risks associated with using a settlement bank.

The Board of Governors of the Federal Reserve System will determine whether systemically important clearing agencies may obtain account access from the Federal Reserve System.

These proposed requirements are meant to reduce the risk that financial obligations related to the activities of a clearing agency are not timely settled or discharged with finality. Failure by a bank to effectuate timely and final settlement adversely affects the clearing

agency by exposing it to credit and liquidity pressures that can destabilize the clearing agency's ability to facilitate prompt and accurate clearance and settlement. Accordingly, the Commission is proposing this new rule, which is designed to limit the potential that the money settlement arrangements cause the clearing agency to face higher levels of credit and liquidity risks and to provide assurance that funds transfers are final when effected. In addition, the Commission preliminarily believes that the proposed rule would assist a clearing agency in meeting the requirement of Section 17A(b)(3)(F) of the Exchange Act, which requires the rules of a clearing agency to be designed to assure the safeguarding of securities and funds which are in the custody or control of the clearing agency or for which it is responsible.

15 U.S.C. 78q-1(b)(3)(F).

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(5). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding money settlement risk sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices regarding money settlement risk of clearing agencies compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices regarding money settlement risk in order to implement the Commission's proposed rule?

• Would it be reasonable to eliminate the clearing agency's credit and liquidity risks from the use of banks to effect money settlements with its participants? If so, how?

• Are there other rules that the Commission should establish regarding money settlement risk management, for example, by mandating the minimum number of banks that a clearing agency may use to effect money settlements with its participants in order to avoid reliance on a small number of such banks, or by specifying characteristics of financial institutions that may be used by clearing agencies for settlement purposes? If so, what would be the appropriate rules and what would be the effect of adopting them?

• Should rules for money settlement risk management established by the Commission be uniform, or are there circumstances in which it would be appropriate for clearing agencies to accept a higher level of money settlement risk, such as when transacting in certain product categories or with certain types of customers? Could the rules proposed by the Commission limit the ability of clearing agencies to compete for certain types of business either within the United States or internationally? Why or why not?

• Should the Commission adopt rules to govern the clearing agency's use of banks that are affiliated with participants in the clearing agency? Should the Commission prohibit this practice? Please explain.

Proposed Rule 17Ad-22(d)(6): Cost-Effectiveness

Proposed Rule 17Ad-22(d)(6) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide that their operations are cost-effective in meeting the requirements of participants while maintaining the safety and security of operations. To maintain safe and secure operations, a clearing agency would need to comply with the requirements under the Exchange Act and the rules thereunder. For example, a clearing agency would need to maintain the ability to comply with any recordkeeping or other regulatory requirement. Having clearing agencies be mindful of the costs that are incurred by their participants, while maintaining such compliance, should help to reduce inefficiencies in the provision of clearing agency services. This is particularly important in circumstances where clearing agencies may not be subject to strong competitive forces (such as when there is only one clearing agency for an asset class) for the provision of their services and therefore may have less of an incentive to be cost-effective in meeting the requirements of participants. Accordingly, the Commission preliminarily believes the proposed rule is appropriate in the public interest, for the protection of investors, because it would potentially help reduce the costs incurred for clearing agency services while also maintaining appropriate standards for a clearing agency's operations.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(6). In addition, the Commission requests comments on the following specific issues:

• Would the proposed rule help to assure that a clearing agency's operations are cost-effective? Does the proposed rule establish a standard for maintaining cost-effectiveness that is sufficiently clear? If not, why not and how might the rule be altered?

• Are there any other requirements that the Commission should include in the rule to help ensure that clearing agencies are cost-effective in providing clearing and settlement services while also maintaining safe and secure operations and compliance with all regulatory requirements?

• Does any specific business model for clearing agencies help to promote cost-effectiveness? Should the business model of a clearing agency affect the type of rule regarding cost-effectiveness that should apply to the clearing agency?

• Should the Commission consider issuing additional guidance on how clearing agencies could be cost-effective in meeting the requirements of participants while maintaining safe and secure operations? If so, what type of guidance would be helpful?

Proposed Rule 17Ad-22(d)(7): Links

Proposed Rule 17Ad-22(d)(7) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to evaluate the potential sources of risks that can arise when the clearing agency establishes links either cross-border or domestically to clear trades, and to ensure that these risks are managed prudently on an ongoing basis.

Section 17A(a)(1)(D) of the Exchange Act states that the linking of all clearance and settlement facilities and the development of uniform standards and procedures for clearance and settlement will reduce unnecessary costs and increase the protection of investors and persons facilitating transactions by and acting on behalf of investors.

Further, Section 17A(b)(3)(F) of the Exchange Act requires that the rules of a clearing agency foster cooperation and coordination with persons engaged in the clearance and settlement of securities transactions.

In the clearance and settlement process, links should help deepen market liquidity and enable participants to trade in other markets.

However, by tying the

clearing operations of different clearing agencies together, link arrangements potentially expose a clearing agency and its members to the risk management profile of another clearing organization and to the risk of financial loss if that clearing organization experiences a default or is otherwise unable to meet its settlement obligations.

15 U.S.C. 78q-1(a)(1)(D).

15 U.S.C. 78q-1(b)(3)(F).

For example, The Depository Trust Company's (“DTC”) Canadian Link Service allows qualifying DTC participants to clear and settle valued securities transactions with participants of a Canadian securities depository. The link is designed to facilitate cross-border transactions by allowing participants to use a single depository interface for U.S. and Canadian dollar transactions and eliminate the need for split inventories.

See

Exchange Act Release Nos. 52784 (November 16,

2005), 71 FR 70902 (November 23, 2005) and 55239 (February 5, 2007), 72 FR 6797 (February 13, 2007) (File No. SR-DTC 2006-15).

A clearing agency may be required to enter into a participant agreement with the other clearing organization as part of the link arrangement, which includes sharing in the loss allocations of that clearing organization.

See

RCCP 4.10.6,

supra

note 29.

Although the design and operation of each link will present a unique risk profile, clearing agencies potentially face legal, operational, credit and liquidity risks from link arrangements. In addition, because links can create interdependencies, clearing agencies may be affected by systemic risk if there are deficiencies in these arrangements. The Commission preliminarily believes that requiring clearing agencies to evaluate and monitor any link arrangements they maintain is essential to protect the marketplaces that clearing agencies serve because the requirement would reduce the likelihood that such arrangements perpetuate risks that could create disruptions in the operations of clearing agencies. Accordingly, the Commission is proposing this rule, which would require clearing agencies to evaluate and manage the risks associated with its links.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(7). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding evaluating link arrangements and prudently managing the associated risks on an ongoing basis sufficiently clear? If not, why not and how might the rule be stated more clearly?

• How do current practices of clearing agencies with respect to link arrangements meet or fail to meet the standard that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices for link arrangements to comply with the Commission's proposed rule?

• Should the Commission include specific requirements regarding the clearing agency's responsibility to evaluate a link for, among other things, the other clearing organization's structure, financial strength, regulatory and disciplinary history, disaster recovery, banking relationships and lines of credit, and risk management controls?

• Should the Commission establish additional requirements for clearing agencies that create linkages with other parties, such as information reporting requirements to the Commission? Would such additional requirements reduce or increase the likelihood that linkages would be established in appropriate circumstances?

• How could clearing agencies ensure that the laws and contractual rules governing linked systems support the design of the link and provide adequate protection to both clearing agencies and their participants? Are additional rules or requirements needed when a link is established with a non-U.S. clearing organization?

• Should the Commission place any limits on or promote the use of linked arrangements in light of potential effects on systemic risk?

Proposed Rule 17Ad-22(d)(8): Governance

Proposed Rule 17Ad-22(d)(8) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to have governance arrangements that are clear and transparent to fulfill the public interest requirements in Section 17A of Exchange Act applicable to clearing agencies,

to support the objectives of owners and participants, and to promote the effectiveness of the clearing agency's risk management procedures.

Section 17A(b)(3)(F) of the Exchange Act requires that the rules of a clearing agency be designed to protect investors and the public interest. 15 U.S.C. 78q-1(b)(3)(F).

Proposed Rule 17Ad-22(d)(8) would complement other applicable requirements concerning governance at clearing agencies that may also separately apply. These other requirements include the existing regulatory framework of Section 17A of the Exchange Act and the related requirements contemplated by proposed Rule 17Ad-25, as well as Section 765 of the Dodd-Frank Act with respect to security-based swap clearing agencies.

See supra

Section III.F. (proposing that clearing agencies be required to establish, implement, maintain and enforce written policies and procedures reasonably designed to identify and address existing or potential conflicts of interest).

See also

Exchange Act Release No. 63107, 75 FR 65882,

supra

note 45.

Clear and transparent governance arrangements promote accountability and reliability in the decisions, rules and procedures of the clearing agency because they provide interested parties (such as owners, participants, and general members of the public) with information about how such decisions are made and what the rules and procedures are designed to accomplish.

The key components of a clearing agency's governance arrangements include the clearing agency's ownership structure, the composition and role of its board, the structure and role of board committees, reporting lines between management and the board, and the processes that ensure management is held accountable for the clearing agency's performance.

The Exchange Act currently requires that certain aspects of a clearing agency's governance arrangements be made clear and transparent. Section 19(b) of the Exchange Act requires that clearing agencies, as SROs, file with the Commission any proposed rule or any proposed change in, addition to, or deletion from the rules of the clearing agency, accompanied by a concise general statement of the basis and purpose of the proposed rule change. 15 U.S.C. 78s(b).

Governance arrangements have the potential to play an important role in making sure that clearing agencies fulfill the Exchange Act requirements that the rules of a clearing agency be designed to protect investors and the public interest and to support the objectives of owners and participants. Similarly, governance arrangements may promote the effectiveness of a clearing agency's risk management procedures by creating an oversight framework that fosters a focus on the critical role that risk management plays in promoting prompt and accurate clearance and settlement.

The role of governance arrangements in promoting effective risk management has also been a focus of rules recently proposed by the Commission to mitigate conflicts of interest at security-based swap clearing agencies.

See

Exchange Act Release No. 63107, 75 FR 65882,

supra

note 45.

The Commission preliminarily believes that the requirements regarding governance arrangements contained in proposed Rule 17Ad-22(d)(8) would be appropriate in the public interest and for the protection of investors because they would enhance the ability of a clearing agency to serve the interests of its various constituents and the interests of the general public while maintaining prudent risk management processes to promote prompt and accurate clearance and settlement.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(8). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding clear and transparent governance arrangements sufficiently clear? If not, why not and how might the rule be stated more clearly?

• Would the proposed rule require clearing agencies to change their current

practices with respect to governance arrangements? If so, how? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices with respect to governance arrangements in order to implement the Commission's proposed rule?

• Are there any other requirements that should be included in the rule to promote clear and transparent governance arrangements, such as mandating specific board or ownership structures? If so, what should they be?

• Should the Commission propose more prescriptive requirements for the governance of all clearing agencies? If so, what should they be? For example, should the Commission specify certain reporting lines or board composition?

• How direct should the Commission's role be in the oversight and monitoring of the composition and activities of clearing agency boards and board committees? If the Commission's role should be more direct, what mechanisms or structure would facilitate the Commission taking such a role? For example, should the Commission consider any additional requirements related to fiduciary duties to either enhance mitigation of conflicts or address deficiencies?

Proposed Rule 17Ad-22(d)(9): Information on Services

Proposed Rule 17Ad-22(d)(9) would require clearing agencies establish, implement, maintain and enforce written policies and procedures reasonably designed to provide market participants with sufficient information for them to identify and evaluate the risks and costs associated with using clearing agencies' services. The types of information that a clearing agency may disclose, as appropriate, to its participants to satisfy this requirement include the clearing agency rulebook,

the costs of its services, a description of netting and settlement activities the clearing agency provides, procedures relating to participants' rights and obligations, information regarding the clearing agency's margin methodology, and information regarding the “extreme but plausible” scenarios that the clearing agency uses to stress test its financial resources. Requiring a clearing agency to disclose information sufficient for participants to identify risks and costs associated with using the clearing agency will allow participants to make informed decisions about the use of the clearing agency and take appropriate actions to mitigate their risks and costs associated with the use of the clearing agency. Accordingly, the Commission's proposed rule is designed to promote participants' understanding of the risks and costs associated with using a clearing agency's services, thereby facilitating prompt and accurate clearance and settlement, safeguarding securities and funds and protecting investors.

Because clearing agencies are SROs, their rules are published by the Commission and are generally available on each clearing agency's Web site. Nevertheless, discrete rule proposals may not necessarily provide a complete picture of a clearing agency's operations and risk mitigation procedures.

See

15 U.S.C. 78q-1(b)(3)(F).

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(9). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding providing market participants with sufficient information to identify and evaluate the risks and costs associated with using the clearing agency's services sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies with respect to providing market participants with information meet or fail to meet the requirements in the proposed rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices in order to implement the proposed requirements?

• Should the Commission consider more detailed requirements concerning disclosure of certain matters such as pricing information and the cost of specific services, as well as default and risk management procedures? Why or why not?

• Should any of the examples of the types of information that a clearing agency may disclose be specifically required to be provided by clearing agencies to their participants or to the public?

Proposed Rule 17Ad-22(d)(10): Immobilization and Dematerialization of Stock Certificates

Proposed Rule 17Ad-22(d)(10) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to immobilize

and dematerialize

securities certificates and transfer them by book entry to the greatest extent possible when the clearing agency provides central securities depository services.

The Commission preliminarily believes that the immobilization and dematerialization of securities and their transfer by book entry would result in reduced costs and risks associated with securities settlements and custody by removing the need to hold and transfer many, if not most, physical certificates.

The Commission also preliminarily believes that the proposed rule would strengthen the requirement in Section 17A(b)(3)(F) of the Exchange Act that requires the rules of a clearing agency to assure the safeguarding of securities and funds that are in the custody or control of the clearing agency or for which it is responsible.

Immobilization refers to any circumstance where an investor does not receive a physical certificate upon the purchase of shares or is required to physically deliver a certificate upon the sale of shares.

Dematerialization is the process of eliminating physical certificates as a record of security ownership.

See

proposed Rule 17Ad-22(a)(2) for definition of “central securities depository services.” In the U.S., DTC is currently the only registered clearing agency that provides central securities depository services.

By concentrating the location of physical securities in a single central securities depository, clearing agencies are able to centralize the operations associated with custody and transfer and reduce costs through economies of scale. Virtually all mutual fund securities, government securities, options, and municipal bonds in the U.S. are dematerialized and most of the equity and corporate bonds in the U.S. market are either immobilized or dematerialized. While the U.S. markets have made great strides in achieving immobilization and dematerialization for institutional and broker-to-broker transactions, many industry representatives believe that the small percentage of securities held in certificated form impose unnecessary risk and expense to the industry and to investors.

See

Exchange Act Release No. 8398 (March 11, 2004), 69 FR 12921 (March 18, 2004).

15 U.S.C. 78q-1(b)(3)(F).

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(10). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding immobilization and dematerialization of securities certificates and transferring them by book entry to the greatest extent possible sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies regarding immobilization and dematerialization of securities certificates compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• What advantages or disadvantages might certificates have over securities

held in book-entry-only form (

e.g.,

proof of ownership in the event of a loss of electronic records of ownership)? Under what circumstances, if any, should the Commission encourage or discourage the use of physical certifications?

Proposed Rule 17Ad-22(d)(11): Default Procedures

Proposed Rule 17Ad-22(d)(11) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to make key aspects of their default procedures publicly available. The Commission preliminarily believes that this would provide certainty and predictability to market participants about the measures a clearing agency will take in the event of a participant default. Key aspects of a clearing agency's default procedures should generally include the following: (i) The circumstances in which action may be taken (

e.g.,

what events trigger mutualization of losses); (ii) who may take those actions (

e.g.,

division of responsibilities when clearing agencies operate links to other clearing agencies); (iii) the scope of the actions that may be taken (

e.g.,

any limits on the total losses that would be mutualized); (iv) the mechanisms to address a clearing agency's obligations to non-defaulting participants (

e.g.,

process for clearing trades guaranteed by the clearing agency to which a defaulting participant is a party); and (v) the mechanisms to address the defaulting participant's obligations to its customers (

e.g.,

process for dealing with defaulting participants' customer accounts). The proposed rule also would require that clearing agencies establish default procedures that ensure that the clearing agency can take timely action to contain losses and liquidity pressures

and to continue meeting its obligations when due in the event of a participant default. Default procedures, among other things, are meant to reduce the likelihood that a default by a participant, or multiple participants, will disrupt the clearing agency's operations. By creating a framework of default procedures that are designed to permit a clearing agency to take actions to contain losses and liquidity pressures it faces while continuing to meet its obligations, the clearing agency should be in a better position to continue providing its services in a manner that promotes accurate clearance and settlement during times of market stress.

A clearing agency may be able to contain liquidity pressures it faces by taking actions to secure additional sources of liquidity or limiting transactions that potentially serve to drain liquidity resources.

The Commission preliminarily believes that the requirements in proposed Rule 17Ad-22(d)(11) would increase the possibility that defaults by participants, should they occur, would proceed in an orderly and transparent manner. This is because the Commission preliminarily believes that the proposed rule would help to ensure that all participants are aware of the default process and are able to plan accordingly and that clearing agencies would have sufficient time to take corrective actions to mitigate potential losses.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(11). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule requiring a clearing agency to establish default procedures and make key aspects of those default procedures publicly available sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies with respect to default procedures compare to the requirements of the proposed rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• Should the Commission require specific default procedures for all clearing agencies, or should clearing agencies have discretion to create their own default procedures consistent with the proposed rule? Should the default procedures include a resolution plan if the clearing agency is unable to obtain sufficient financial resources?

• How much flexibility should a clearing agency have in the time it takes to manage a default and perform any liquidation of positions?

Proposed Rule 17Ad-22(d)(12): Timing of Settlement Finality

Proposed Rule 17Ad-22(d)(12) would require clearing agencies establish, implement, maintain and enforce written policies and procedures reasonably designed to ensure that final settlement occurs no later than the end of the settlement day and that intraday or real-time finality is provided where necessary to reduce risks. A clearing agency would be able to comply with this requirement by having a reasonable process for facilitating final settlement to occur no later than the end of the settlement day and for providing intraday or real-time finality where necessary to reduce risks. Intraday or real-time finality may be necessary to reduce risk in circumstances where the lack of intraday or real-time finality may impede the clearing agency's ability to facilitate prompt and accurate clearance and settlement, cause the clearing agency's participants to fail to meet their obligations, or cause significant disruptions in the securities markets.

The Commission preliminarily believes that requiring intraday or real-time finality for settlements, where such requirement is necessary to reduce risks, would facilitate prompt and accurate clearance and settlement by providing certainty that a settlement is final and irrevocable within a timeframe that is commensurate with the level of risk created by the lack of settlement finality. The risks associated with lack of settlement finality stem from the undermining of confidence that transaction obligations will be discharged by the clearing agency or its participants. Moreover, the Commission preliminarily believes that settlement finality should occur not later than the end of the settlement day to limit the volume of outstanding obligations that are subject to settlement at any one time and thereby reduce the settlement risk exposure of participants and the clearing agency.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(12). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding the timing of settlement finality sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies with respect to settlement finality compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• What changes, if any, would be created by the requirement under the proposed rule that final settlement occur no later than the end of the settlement day? Does the proposed rule affect certain identifiable categories of market participants differently than others, such as smaller entities or entities with limited operations in the U.S.? If so, how?

• Are there operational, legal or regulatory impediments to intraday or real-time settlement? Will the proposed standard make it harder for clearing agencies to conduct certain types of business for which intraday or real-time finality may be difficult? Are any additional rules or regulations needed to encourage intraday or real-time finality to reduce risks?

• Are there circumstances when the requirements of intraday, real-time or end of day settlement finality proposed by the rule are not feasible or are not beneficial? If so, in what circumstances?

Proposed Rule 17Ad-22(d)(13): Delivery Versus Payment

Proposed Rule 17Ad-22(d)(13) would require clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to eliminate principal risk by linking securities transfers to funds transfers to achieve delivery versus payment (“DVP”). DVP is achieved in the settlement process when the mechanisms facilitating settlement ensure that delivery occurs if and only if payment occurs.

See

Bank for International Settlements,

Delivery Versus Payment in Securities Settlement Systems

(1992),

available at http://www.bis.org/publ/cpss06.pdf.

Three different DVP models can be differentiated according to whether the securities and/or funds transfers are settled on a gross (trade-by-trade) basis or on a net basis.

Among other things, DVP eliminates the risk that a party would lose some or its entire principal because payment is made only if securities are delivered. The Commission preliminarily believes that clearing agencies should be required to use this payment method in order to reduce the potential that delivery of the security is not appropriately matched with payment for a security, thereby impeding the clearing agency's ability to facilitate prompt and accurate clearance and settlement. Therefore, the Commission is proposing that clearing agencies be required to link securities transfers to funds transfers in a way that achieves DVP.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(13). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding using DVP to eliminate principal risk by linking securities transfers to funds transfers sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies for linking securities transfers to funds transfers compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• What are the advantages and disadvantages of the proposed rule mandating a strict DVP standard? Does the proposed rule affect certain identifiable categories of clearing agencies differently than others, such as clearing agencies with more diversified post-trade services as compared to clearing agencies that specialize in fewer activities?

• Are there operational or legal impediments to implementing the proposed DVP rule? Would the proposed rule make it more difficult for clearing agencies to conduct certain types of business that may require a longer settlement cycle, for reasons outside of the clearing agency's control? Are any additional rules or regulations needed to support achievement of the proposed DVP rule?

• Are there circumstances when DVP is not feasible or practicable? If so, when?

Proposed Rule 17Ad-22(d)(14): Risk Controls To Address Participants' Failure To Settle

Proposed Rule 17Ad-22(d)(14) requires clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to institute risk controls, including collateral requirements and limits to cover the clearing agency's credit exposure to each participant exposure fully, that ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle when the clearing agency provides central securities depository services

and extends intraday credit to participants.

See

proposed Rule 17Ad-22(a)(2) for definition of “central securities depository services.”

Clearing agencies that provide central securities depository services may sometimes extend intraday credit to participants to, among other things, facilitate timely settlements by providing participants with an additional tool to meet delivery obligations. If a participant fails to settle its obligations to the clearing agency, the clearing agency must cover those obligations to be able to continue to facilitate prompt and accurate clearance and settlement.

The Commission preliminarily believes it is important for clearing agencies that provide central securities depository services to institute risk controls, including collateral requirements and limits to cover the clearing agency's credit exposure to each participant exposure fully, that ensure timely settlement in these circumstances to address the risk that the participant may fail to settle after credit has been extended. The Commission also preliminarily believes that requiring the controls to be designed to withstand the inability of the participant with the largest payment obligation to settle, in such circumstances, would reduce the likelihood of disruptions at the clearing agency by having controls in place to account for the largest possible loss from any individual participant and thereby help the clearing agency to provide prompt and accurate clearance and settlement during times of market stress.

As previously indicated, IOSCO and the CPSS are currently in the process of revising their existing sets of international standards which include those related to a clearing agency's ability to withstand participant failures and to meet payment obligations.

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(14). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding risk controls to ensure timely settlement for a clearing agency providing central securities depository services sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies that provide central securities depository services compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• In addition to collateral requirements and limits on credit exposure to participants, are there other controls on intra-day credit that could be effective in managing settlement risk? If so, should the Commission require the use of any of these other risk controls?

• What are the advantages and disadvantages of requiring that controls be designed to withstand a failure to

settle by the participant with the largest payment obligation?

• Should the Commission require that the clearing agency be able to withstand a settlement failure by more than the largest participant? For example, should the Commission require the clearing agency be able to withstand a settlement failure by the participants with the two largest payment obligations? Why or why not?

Proposed Rule 17Ad-22(d)(15): Physical Delivery Risks

Proposed Rule 17Ad-22(d)(15) would require clearing agencies establish, implement, maintain and enforce written policies and procedures reasonably designed to disclose to their participants the clearing agency's obligations with respect to physical deliveries.

For example, if a clearing agency (as part of its operations) takes physical delivery of securities from its participants in return for payments of cash, then it must inform its participants of the extent of the clearing agency's obligations to make payment. A statement by the clearing agency to its participants about the clearing agency's obligations with respect to physical deliveries, among other things, would help to ensure that participants have information that is likely to enhance the participants' understanding of their rights and responsibilities with respect to using the clearance and settlement services of the clearing agency. The Commission preliminarily believes that providing such information to participants would promote a shared understanding regarding physical delivery practices between the clearing agency and its participants which could help reduce the potential for fails and thereby facilitate prompt and accurate clearance and settlement.

The proposed rule would provide clearing agencies with the flexibility to determine the method by which the clearing agency will state this information to its participants. However, the clearing agencies should take care to develop an approach that provides sufficient notice to its participants regarding the clearing agency's obligations.

The proposed rule would also require clearing agencies to reasonably design their operations to identify and manage the risks that arise in connection with their obligations for physical deliveries. The risks associated with physical deliveries could stem from, among other factors, operational limitations with respect to assuring receipt of physical deliveries and processing of physical deliveries. The Commission preliminarily believes that requiring clearing agencies to identify and manage these risks would reduce the potential that issues will arise as a result of physical deliveries because the clearing agency will have acted preemptively to deal with potential issues that may disrupt the clearance and settlement process. Accordingly, the Commission preliminarily believes this requirement would help a clearing agency to facilitate prompt and accurate clearance and settlement consistent with Section 17A of the Exchange Act.

15 U.S.C. 78q-1(b)(3)(F).

Request for Comment

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(d)(15). In addition, the Commission requests comments on the following specific issues:

• Is the Commission's proposed rule regarding providing information regarding physical delivery and identifying and managing risks associated with physical delivery sufficiently clear? If not, why not and what would be a better alternative?

• How do current practices of clearing agencies with respect to physical delivery compare to the practices that the Commission proposes to require in this rule? What are the expected incremental costs to clearing agencies in connection with adding to or revising their current practices in order to implement the Commission's proposed rule?

• What type of information would be useful for participants to receive from a clearing agency regarding the clearing agency's obligations to participants with respect to physical deliveries? What are the advantages or disadvantages of including specific disclosure requirements with respect to any of this information?

• Are there physical delivery obligations that clearing agencies should not assume or for which the Commission should consider additional restrictions?

B. Proposed Rule 17Aj-1 Dissemination of Pricing and Valuation Information by Security-Based Swap Clearing Agencies That Perform Central Counterparty Services

The Commission is proposing Rule 17Aj-1 to incorporate requirements regarding dissemination of pricing and valuation information in the CDS Clearing Exemption Orders into the Commission's rules for security-based swap clearing agencies.

Recently, the Commission voted to extend these temporary conditional exemptions from certain provisions of the Federal securities laws until July 16, 2011 to continue to facilitate central clearing of certain CDS.

The proposed rule is designed in part to continue the existing dissemination requirements from the CDS Clearing Exemption Orders which would otherwise expire along with those exemption orders.

See, e.g.,

the CDS Clearing Exemption Order relating to ICE Trust. “[T]his temporary extension is conditioned on ICE Trust, directly or indirectly, making available to the public on terms that are fair and reasonable and not unreasonably discriminatory: (i) All end-of-day settlement prices and any other prices with respect to Cleared CDS that ICE Trust may establish to calculate mark-to-market margin requirements for ICE Trust clearing members; and (ii) any other pricing or valuation information with respect to Cleared CDS as is published or distributed by ICE Trust.” Exchange Act Release No. 63387 (November 29, 2010) 75 FR 75502 (December 3, 2010).

The extensions of the temporary conditional exemptions applied to central clearing of certain CDS by ICE Trust, ICE Clear Europe, CME and Eurex.

See

Exchange Act Release Nos. 63389 (November 29, 2010), 75 FR 75520 (December 3, 2010); 63390 (November 29, 2010), 75 FR 75518 (December 3, 2010); 63388 (November 29, 2010), 75 FR 75522 (December 3, 2010); 63387 (November 29, 2010) 75 FR 75502 (December 3, 2010) (extending the CDS Clearing Exemption Orders for ICE Clear, Eurex, CME and ICE Trust respectively).

Proposed Rule 17Aj-1 would require dissemination of pricing and valuation information by security-based swap clearing agencies that perform CCP services.

In particular, proposed Rule 17Aj-1 would require each security-based swap clearing agency that performs CCP services to make available to the public, on terms that are fair, reasonable, and not unreasonably discriminatory,

all end-of-day settlement prices and any other prices for security-based swaps that the clearing agency may establish to calculate its participants' mark-to-market

margin requirements and any

other price or valuation information with respect to security-based swaps as is published or distributed by the clearing agency to its participants.

The Commission preliminarily believes this requirement should apply to security-based swap clearing agencies that perform CCP services because, based on the Commission's oversight experience pursuant to the CDS Clearing Exemption Orders, price and valuation information with respect to security-based swaps may often be limited and such a requirement could help to provide information to market participants that may otherwise only be available to the participants of a particular clearing agency. Clearing agencies that clear standard securities may not face similar limitations on price and valuation information. As a result, the Commission is proposing this rule only with respect to security-based swap clearing agencies that perform CCP services but is requesting comment on whether the rule should apply more broadly.

Under the proposed rule, security-based swap clearing agencies would be permitted to use different approaches to make certain pricing and valuation information available to the public. For example, some may choose to engage the services of a third-party vendor while others may make the information directly available through the clearing agency's Web site or some other means.

Proposed Rule 17Aj-1 does not prohibit charges that may be assessed with respect to security-based swap clearing agencies making this information available to the public as long as such charges are fair, reasonable, and not unreasonably discriminatory. The fair, reasonable, and not unreasonably discriminatory requirements for open access to information pursuant to proposed Rule 17Aj-1 are consistent with requirements the Commission adopted pursuant to the CDS Clearing Exemption Orders as well as in Rule 603(a) of Regulation NMS which requires all exchanges, alternative trading systems, and other broker-dealers that offer individual data feeds to make the data available on terms that are fair and reasonable and not unreasonably discriminatory.

See

17 CFR 242.603(a).

In this specific context of the margin practices of security-based swap clearing agencies, the term “mark-to-market” refers to the variation margin practices used by a clearing agency to account for ongoing fluctuations in the market value of its participants' security-based swap positions.

Clearing agencies may destroy or otherwise dispose of records at the end of five years consistent with Rule 17a-6 of the Exchange Act.

See

17 CFR 240.17a-6.

As noted above, the Commission granted the CDS Clearing Exemption Orders to promote the use of CCPs with respect to CDS.

Section 763(b) of the Dodd-Frank Act provides that certain security-based swap clearing agencies will be deemed registered for the purpose of clearing security-based swaps (“Deemed Registered Provision”).

The Deemed Registered Provision becomes effective on July 16, 2011.

After the Deemed Registered Provision becomes effective, certain clearing agencies would no longer need an exemption from registration as a clearing agency under Section 17A of the Exchange Act in order to clear security-based swaps.

Proposed Rule 17Aj-1 would require securities-based swap clearing agencies that perform CCP services, once registered, to make publicly available the same pricing and valuation information required by the CDS Clearing Exemption Orders.

See

discussion

supra

in Section I.

See

Public Law 111-203 § 763(b) (adding new Section 17A(l) to the Exchange Act. Under this Deemed Registered Provision, eligible clearing agencies will be required to comply with all requirements of the Exchange Act, and the rules thereunder, applicable to registered clearing agencies to the extent it clears security-based swaps after the effective date of the Deemed Registered Provision, including, for example, the obligation to file proposed rule changes under Section 19(b) of the Exchange Act.

See

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.